UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 20-F
(Mark One)
(cid:133) REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR 12(g) OF THE
SECURITIES EXCHANGE ACT OF 1934
OR
⌧ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 2015
OR
(cid:133) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
OR
(cid:133) SHELL COMPANY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Date of event requiring this shell company report
Commission file number: 001-34238
THE9 LIMITED
(Exact name of Registrant as specified in its charter)
N/A
(Translation of Registrant’s name into English)
Cayman Islands
(Jurisdiction of incorporation or organization)
Building No. 3, 690 Bibo Road
Zhang Jiang Hi-Tech Park
Pudong New Area, Pudong
Shanghai 201203
People’s Republic of China
(Address of principal executive offices)
George Lai, Chief Financial Officer
Tel: +86-21-5172-9999
Facsimile number: +86-21-5172-9903
Building No. 3, 690 Bibo Road
Zhang Jiang Hi-Tech Park
Pudong New Area, Pudong
Shanghai 201203
People’s Republic of China
(Name, Telephone, E-mail and/or Facsimile number and Address of Company Contact Person)
Securities registered or to be registered pursuant to Section 12(b) of the Act:
Title of Each Class
American Depositary Shares, each representing
one ordinary share, par value US$0.01 per share
Name of Each Exchange on Which Registered
Nasdaq Global Market
Securities registered or to be registered pursuant to Section 12(g) of the Act:
None
(Title of Class)
Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act:
None
(Title of Class)
Indicate the number of outstanding shares of each of the issuer’s classes of capital or common stock as of the close of the period
covered by the annual report.
37,283,929 ordinary shares, par value US$0.01 per share, as of December 31, 2015.
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities
Act. (cid:133) Yes ⌧ No
If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to
Section 13 or 15(d) of the Securities Exchange Act of 1934. (cid:133) Yes ⌧ No
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities
Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports),
and (2) has been subject to such filing requirements for the past 90 days. ⌧ Yes (cid:133) No
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every
Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or
for such shorter period that the registrant was required to submit and post such files). ⌧ Yes (cid:133) No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition
of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer (cid:133) Accelerated filer (cid:133) Non-accelerated filer ⌧
Indicate by check mark which basis of accounting the registrant has used to prepare the financial statements included in this filing:
U.S. GAAP ⌧
International Financial Reporting Standards as issued
by the International Accounting Standards Board (cid:133)
Other (cid:133)
* If “Other” has been checked in response to the previous question, indicate by check mark which financial statement Item the
registrant has elected to follow. (cid:133) Item 17 (cid:133) Item 18
If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange
Act). (cid:133) Yes ⌧ No
(APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE PAST FIVE YEARS)
Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13 or 15(d) of
the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. (cid:133) Yes (cid:133) No
INTRODUCTION
PART I
TABLE OF CONTENTS
Item 1.
Item 2.
Item 3.
Item 4.
Item 4A.
Item 5.
Item 6.
Item 7.
Item 8.
Item 9.
Item 10.
Item 11.
Item 12.
IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS
OFFER STATISTICS AND EXPECTED TIMETABLE
KEY INFORMATION
INFORMATION ON THE COMPANY
UNRESOLVED STAFF COMMENTS
OPERATING AND FINANCIAL REVIEW AND PROSPECTS
DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES
MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS
FINANCIAL INFORMATION
THE OFFER AND LISTING
ADDITIONAL INFORMATION
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES
PART II
Item 13.
Item 14.
DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES
MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF
PROCEEDS
Item 15.
Item 16A.
Item 16B.
Item 16C.
Item 16D.
Item 16E.
Item 16F.
Item 16G.
Item 16H.
CONTROLS AND PROCEDURES
AUDIT COMMITTEE FINANCIAL EXPERT
CODE OF ETHICS
PRINCIPAL ACCOUNTANT FEES AND SERVICES
EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES
PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS
CHANGE IN REGISTRANT’S CERTIFYING ACCOUNTANT
CORPORATE GOVERNANCE
MINE SAFETY DISCLOSURE
PART III
Item 17.
Item 18.
Item 19.
FINANCIAL STATEMENTS
FINANCIAL STATEMENTS
EXHIBITS
SIGNATURES
i
1
2
2
2
2
34
49
49
70
77
80
81
82
94
95
96
96
96
97
98
98
98
98
98
99
99
99
99
99
99
99
103
INTRODUCTION
In this annual report, unless otherwise indicated, (1) the terms “we,” “us,” “our company,” “our” and “The9” refer to The9
Limited and, as the context may require, its subsidiaries and our consolidated affiliated entities, (2) the terms “affiliated entities” and
“affiliated PRC entities” refer to our consolidated affiliated PRC entities, including, among others, Shanghai The9 Information
Technology Co., Ltd., or Shanghai IT, in which we do not have direct equity interests but over which we effectively control through a
series of contractual arrangements as described under “Item 7. Major Shareholders and Related Party Transactions—B. Related Party
Transactions— Arrangements with Affiliated PRC Entities”, (3) the terms “shares” and “ordinary shares” refer to our ordinary shares,
and “ADSs” refers to our American depositary shares, each of which represents one ordinary share, (4) “China” and “PRC” refer to
the People’s Republic of China, and solely for the purpose of this annual report, excluding Taiwan, Hong Kong and Macau, (5) all
references to “RMB” and “Renminbi” are to the legal currency of China and all references to “U.S. dollars,” “dollars,” “US$” and
“$” are to the legal currency of the United States, (6) all discrepancies in any table between the amounts identified as total amounts
and the sum of the amounts listed therein are due to rounding, and (7) all translations from RMB to U.S. dollars and from U.S. dollars
to RMB in this annual report were made at a rate of RMB6.4778 to US$1.00, based on the H.10 weekly statistical release of the
Federal Reserve Bank of New York as of December 31, 2015. Such translations have been provided for the convenience of the reader
only and should not be construed as representations that the RMB amounts represent, or have been or could be converted into, United
States dollars at that or any other rate.
1
PART I
Item 1.
IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS
Not Applicable.
Item 2.
OFFER STATISTICS AND EXPECTED TIMETABLE
Not Applicable.
Item 3.
KEY INFORMATION
A.
Selected Financial Information
The following table presents selected consolidated financial information for our company. You should read the following
information in conjunction with “Item 5. Operating and Financial Review and Prospects” below. The selected consolidated statement
of operations data for the years ended December 31, 2013, 2014 and 2015 and the selected consolidated balance sheet data as of
December 31, 2014 and 2015 have been derived from our audited consolidated financial statements and should be read in conjunction
with those statements, which are included in this annual report beginning on page F-1. The selected consolidated statement of
operations data for the years ended December 31, 2011 and 2012 and the selected consolidated balance sheet data as of December 31,
2011, 2012 and 2013 have been derived from our audited consolidated financial statements, which are not included in this annual
report. The consolidated financial statements were prepared and presented in accordance with United States generally accepted
accounting principles, or U.S. GAAP.
For the Year Ended December 31,
2011
RMB
2012
RMB
2013
RMB
2014
RMB
2015
RMB
US$(1)
(in thousands, except for per share and per ADS data)
Consolidated Statement of Operation Data
Revenues
Sales taxes
Net revenues
Cost of revenue
Gross profit (loss)
Operating expenses
Other operating income (expense)
Loss from operations
Impairment on investments
Interest income
Interest expenses
Fair value change on warrants liability
Gain on disposal of equity investee and available-for-sale
investment
Other income (expenses), net
Loss before income tax expense and share of loss in equity
method investments
Impairment loss on investments
Share of loss in equity investments
112,466
(6,089)
106,377
(39,118)
67,259
163,581
(9,147)
154,434
(69,416)
85,018
(477,284) (677,529)
120
(384,032) (592,391)
—
21,786
—
—
—
30,416
—
—
25,993
(563)
106,627
(1,851)
64,840 46,610
(199)
104,776
64,277 46,411
(107,803) (85,783) (67,744)
(3,027) (21,506) (21,333)
(527,341) (139,404) (303,604)
(1,563)
(530,248) (160,835) (326,500)
(47,971) — —
775
(6,397)
(7,129)
3,415
—
—
8,376
—
—
75
120
7,195
(30)
7,165
(10,458)
(3,293)
(46,868)
(242)
(50,403)
—
120
(987)
(1,101)
44,435
(653)
15,726
4,644
—
9,302
33,154 —
(1,917)
(963)
—
(296)
(309,834) (550,235)
(3,244)
(6,347)
—
(3,342)
(560,541) (125,229) (341,168)
— —
(3,713) (13,014)
—
(2,376)
(52,667)
—
(2,009)
2
Net loss for the year
Other comprehensive income (loss)
Unrealized loss on available-for-sale investment
Currency translation adjustments
Total comprehensive loss
Net loss attributable to:
Noncontrolling interest
Redeemable noncontrolling interest
The9 Limited
Change in redemption value of redeemable noncontrolling
interest
Net loss attributable to holders of ordinary shares
Comprehensive loss attributable to:
Noncontrolling interest
Redeemable noncontrolling interest
The9 Limited
Change in redemption value of redeemable noncontrolling
interest
Comprehensive loss attributable to holders of ordinary shares
Net loss attributable to holders of ordinary shares per share
Basic
Diluted
Net loss attributable to holders of ordinary shares per ADS(2)
Basic
Diluted
For the Year Ended December 31,
2011
RMB
2012
RMB
2013
RMB
2014
RMB
2015
RMB
US$(1)
(in thousands, except for per share and per ADS data)
(313,176) (559,826)
(562,917) (128,942) (354,182)
(54,676)
—
(4,305)
(57)
(980)
(317,481) (560,863)
(16) — —
5,009
(1,204)
(563,622) (130,146) (349,173)
(689)
—
773
(53,903)
(28,846)
—
(45,824)
—
(284,330) (514,002)
(36,655) (21,443) (16,656)
(20,877) (32,698)
(526,262) (86,622) (304,828)
—
(2,571)
(5,048)
(47,057)
—
—
(284,330) (514,002)
—
21,077 79,806
(526,262) (107,699) (384,634)
12,320
(59,377)
(29,280)
—
(46,118)
—
(288,201) (514,745)
(35,084) (22,995) (16,913)
(20,877) (32,698)
(528,538) (86,274) (299,562)
—
(2,611)
(5,048)
(46,244)
—
—
—
21,077 79,806
12,320
(288,201) (514,745)
(528,538) (107,351) (379,368)
(58,564)
(11.39)
(11.39)
(20.98)
(20.98)
(22.71)
(22.71)
(4.65)
(4.65)
(16.55)
(16.55)
(11.39)
(11.39)
(20.98)
(20.98)
(22.71)
(22.71)
(4.65)
(4.65)
(16.55)
(16.55)
(2.56)
(2.56)
(2.56)
(2.56)
As of December 31,
2011
RMB
2012
RMB
2013
RMB
2014
2015
RMB RMB
US$(1)
(in thousands)
Consolidated Balance Sheet Data
554,279 156,987 181,482 49,011
7,566
1,071,726
Cash and cash equivalents
460,228
447,730 328,617 261,477 460,837 71,141
Non-current assets
1,628,894 1,112,345 546,679 517,331 538,095 83,068
Total assets
317,713 330,092 296,591 427,966 66,067
311,525
Total current liabilities
749,212 190,133 64,888 (241,076) (37,216)
1,251,831
Total equity
Redeemable noncontrolling interest
— — 131,497 178,605 27,572
—
Total liabilities, redeemable noncontrolling interest and equity 1,628,894 1,112,345 546,679 517,331 538,095 83,068
(1) Translation from RMB amounts into U.S. dollars was made at a rate of RMB6.4778 to US$1.00 for the convenience of the
reader only. See “Item 3. Key Information—A. Selected Financial Information— Exchange Rate Information.”
(2) Each ADS represents one ordinary share.
Exchange Rate Information
Our business is primarily conducted in China and a significant portion of our revenues are denominated in RMB. This
annual report contains translations of RMB amounts into U.S. dollars based on the exchange rate set forth in the H.10 statistical
release of the Federal Reserve Bank of New York. For the convenience of the readers only, this annual report contains translations of
some RMB or U.S. dollar amounts for 2015 at US$1.00 to RMB6.4778, which was the noon buying rate in effect as of December 31,
2015. The prevailing rate on April 1, 2016 was US$1.00 to RMB6.4776. We make no representation that any RMB or U.S. dollar
amounts could have been, or could be, converted into U.S. dollars or RMB, as the case may be, at any particular rate, the rates stated
below, or at all. See “Item 3. Key Information—D. Risk Factors—Risks Related to Doing Business in China—Future movements in
exchange rates between the U.S. dollar and the RMB may adversely affect the value of our ADSs.”
3
The following table sets forth information concerning exchange rates between the RMB and the U.S. dollar for the periods
indicated. These rates are provided solely for your convenience and are not necessarily the exchange rates that we used in this annual
report or will use in the preparation of our other periodic reports or any other information to be provided to you.
Period
2011
2012
2013
2014
2015
October
November
December
2016
January
February
March
April (through April 1)
Noon Buying Rate
Period end Average(1)
6.4475
6.2990
6.1412
6.1704
6.2827
6.3505
6.3640
6.4491
6.2939
6.2301
6.0537
6.2046
6.4778
6.3180
6.3883
6.4778
Low
6.6364
6.3879
6.2438
6.2591
6.4896
6.3591
6.3945
6.4896
High
6.2939
6.2221
6.0537
6.0402
6.1870
6.3180
6.3180
6.3883
6.5752
6.5525
6.4480
6.4776
6.5726
6.5501
6.5027
6.4776
6.5932
6.5795
6.5500
6.4776
6.5219
6.5154
6.4480
6.4776
(1) Annual averages are calculated from month-end rates. Monthly averages are calculated using the average of the daily rates
during the relevant period.
B. Capitalization and Indebtedness
Not Applicable.
C. Reasons for the Offer and Use of Proceeds
Not Applicable.
D. Risk Factors
Risks Related to Our Company and Our Industry
We may continue to incur losses, negative cash flows from operating activities and net current liabilities in the future. If we are
not able to return to profitability or raise sufficient capital to cover our capital needs, we may not continue as a going concern.
We incurred a net loss of RMB562.9 million, RMB128.9 million and RMB354.2 million (US$54.7 million) for the years
ended December 31, 2013, 2014 and 2015, respectively, as we continue to incur product development and sales and marketing
expenses for our new products and general and administrative expenses while we have not generated significant revenues from the
new games we are currently developing or about to launch. Our operating expenses may increase in the future as we continue to
explore various opportunities of new product development and business expansion in order to grow our revenues. In addition, in
2013, 2014 and 2015, we recorded a gross loss of RMB3.0 million, RMB21.5 million and RMB21.3 million (US$3.3 million),
respectively, reflecting lower revenues generated coupled with the continued incurrence of a relatively fixed portion of our costs, such
as overhead, depreciation and rental charges. Our ability to achieve profitability depends on the competitiveness of our products and
services as well as our ability to control costs and to provide new products and services to meet the market demands and attract new
customers. Due to the numerous risks and uncertainties associated with our business, we may not be able to achieve profitability in
the short-term or long-term.
4
In addition, our cash and cash equivalents have significantly and generally decreased since 2009, primarily due to the cash
outflows from operating activities associated with our product development and sales and marketing efforts for our new games. Our
cash and cash equivalents continued to decrease from RMB181.5 million as of December 31, 2014 to RMB49.0 million (US$7.6
million) as of December 31, 2015, primarily due to cash outflows to finance capital investment in our joint venture Oriental Shiny
Star Limited, or Oriental Shiny, for licensing CrossFire 2 and operating activities for product development and sales and marketing,
offset by cash received from the issuance and sale of the Convertible Notes and proceeds from an entrusted loan in December 2015.
We recorded negative operating cash flow of RMB357.6 million, RMB269.1 million and RMB175.6 million (US$27.1 million) for
the years ended December 31, 2013, 2014 and 2015, respectively. Furthermore, as of December 31, 2013, 2014 and 2015, we
recorded net current liabilities of RMB112.0 million, RMB40.7 million and RMB350.7 million (US$54.1 million), respectively. Our
net current liabilities positions as of December 31, 2013, 2014 and 2015 were primarily due to the continuous cash outflow in
connection with our product development and sales and marketing activities. See “Item 5—Operating and Financial Review and
Prospects—A. Operating Results—Results of Operations.” We cannot assure you that our liquidity position will improve in the
future. We may continue to incur losses, negative cash flows from operating activities and net current liabilities, which may
materially and adversely affect our business, prospects, liquidity, financial condition and results of operations.
If we are unable to achieve profitability or raise sufficient capital to cover our capital needs, we may not continue as a
going concern. There can be no assurance that we can obtain additional financing. Our ability to obtain additional financing is subject
to a number of factors, which may be beyond our control. See “—We may not be able to obtain additional financing to support our
business and operations, and our equity or debt financings may have an adverse effect on our business operations and share price.”
Our consolidated financial statements for each of the three years ended December 31, 2015 included in this annual report
beginning on page F-1 have been prepared based on the assumption that we will continue on a going concern basis. The auditors of
our consolidated financial statements have included in their audit report an explanatory paragraph relating to substantial doubt about
our ability to continue as a going concern. Our consolidated financial statements do not include any adjustments relating to the
recoverability and classification of recorded asset amounts or amounts of liabilities that might result from the outcome of this
uncertainty.
Our business is intensely competitive and “hit” driven. If we do not deliver new “hit” products to the market, or if consumers
prefer our competitors’ products or services over those we provide, our operating results will suffer.
We operate in a highly competitive and dynamic market, and our future success depends not only on the popularity of our
existing online games but also, in a large part, on our ability to develop and introduce new games that are attractive to our customers.
To achieve this, we need to anticipate and effectively adapt to rapidly changing consumer tastes and preferences and technological
advances. The development of new games and the procurement of licenses from third-party developers can be very difficult and
requires high levels of innovation and significant investments. We currently focus on and have made significant investment in
developing our own proprietary games, primarily mobile games and massively multiplayer online first-person shooter game, or
MMOFPSs. However, we do not have a proven track record of developing such games or other online games. While new products are
regularly introduced, only a small number of “hit” titles account for a significant portion of total revenues in our industry. We may
decide to cease to operate or develop any game that is no longer profitable. There is no assurance that any new game, proprietary,
licensed or otherwise, to be introduced by us from time to time, including those named in “Item 4. Information on the Company—B.
Business Overview—Products and Services,” could become “hit” products and widely accepted by the customers and the market. We
may continue to incur losses, and experience net cash outflow from operating activities, decrease in cash and cash equivalents balance
and net current liabilities if we fail to introduce “hit” games or products which gain substantial market acceptance. In addition, “hit”
products offered by our competitors may take a larger share of the market than we anticipate, which could cause revenues generated
by our products to fall below expectations. Our competitors may develop more successful products, or offer similar products at lower
price points or pursuant to payment models viewed as offering a better value than we do. Any such negative development may
materially and adversely affect our business, financial condition and results of operations.
We need to continue to develop and release upgrades to our new online games. We cannot assure you that we will be able
to identify appropriate games or enter into arrangements with those game developers to offer these games in China on terms
acceptable to us or at all, or that we can maintain the expected life span of our new online games. If we are not able to license,
develop or acquire additional, attractive online games with strong or lasting appeal to users, our business, financial condition and
results of operations may be materially and adversely affected.
5
We currently depend on a limited number of games, and we may not be able to successfully implement our growth strategies.
We currently depend on a limited number of games for substantially all of our revenues. In addition, we are currently
focusing on developing a number of proprietary games and obtaining licenses to games to grow our business. Red 5 Studios, Inc., or
Red 5, a subsidiary which we acquired in 2010, has developed Firefall, a MMOFPS game, for which we conducted a limited
commercial release in China in November 2015 and expect to have a large-scale commercial launch in China in the second half of
2016. In November 2015, our joint venture Oriental Shiny obtained an exclusive license from Smilegate Entertainment Inc., or
Smilegate, to publish and operate CrossFire 2 in China for an initial term of three years. Smilegate is currently in the process of
developing CrossFire 2. However, there is no assurance that we or Smilegate can successfully develop the games we invest in, that
we may successfully launch the games as expected on a timely basis, or at all, or if any newly launched games such as Firefall and
CrossFire 2 would be widely accepted by game players. We have also invested in developing our proprietary mobile games in China,
including Song of Knights and Winning Goal. Our business strategies may also involve the development and marketing of new
products and services for which there are no established markets in China or in which we lack experience and expertise. If any of our
games encounters any adverse development or if we are unable to develop, purchase or license additional games that are attractive to
users, our business, financial condition and results of operations may be materially and adversely affected. We cannot assure you that
we will be able to launch new games or continue operating existing games on a commercially viable basis or in a timely manner, or at
all, or that we will be able to implement our other growth strategies. If any of these occur, our competitiveness may be harmed and
our business, financial condition and results of operations may be materially and adversely affected.
We may not be able to obtain additional financing to support our business and operations, and our equity or debt financings may
have an adverse effect on our business operations and share price.
We may continue to experience material decrease in cash and cash equivalents balance and we may require additional cash
resources to fund our working capital and expenditure needs, such as product developments expenses, payment of license fees and
royalties, sales and marketing activities, investment or acquisition transactions. We expect to incur product development costs to
develop our proprietary online games, including mobile games and MMOFPSs, and license fees and royalties to obtain game licenses
from third-party developers. If our internal financial resources are insufficient to satisfy our cash requirements, we may seek
additional financing through the issuance of equity securities or through debt financing, such as borrowings from commercial banks
or other financial institutions or lenders. To meet our anticipated capital needs, we are considering multiple alternatives, including but
not limited to additional equity financings, debt financings, other financing transactions, and cost control. See “Item 5. Operating and
Financial Review and Prospects—B. Liquidity and Capital Resources—Cash Flows and Working Capital.” There can be no assurance
that we will be able to successfully complete any such transaction or conduct any cost control measure with results favorable to us, or
at all. If we are unable to obtain the necessary financing, we may need to license or sell our assets, seek to be acquired by another
entity and/or cease operations.
Any equity or debt financing may result in dilution to our existing shareholders’ interests or an increase in our debt service
obligations. For example, in December 2015, we issued and sold senior secured convertible notes, or the Convertible Notes, in an
aggregate principal amount of US$40,050,000 to Splendid Days Limited, or Splendid Days, in three tranches at initial conversion
prices of US$2.6, US$5.2 and US$7.8 per ADS, respectively. In connection with the sale of Convertible Notes, we also issued
warrants, or the Warrants, in an aggregate principal amount of US$9,950,000 to Splendid Days in four tranches at initial exercise
prices of US$1.5, US$2.6, US$5.2 and US$7.8 per ADS, respectively. In addition, in December 2015, we obtained an entrusted loan
of approximately RMB31.6 million (US$4.9 million) from a third party. See “Item 5. Operating and Financial Review and
Prospects—B. Liquidity and Capital Resources—Cash Flows and Working Capital.” The Convertible Notes and the aforesaid loan
significantly increased our debt obligations and any conversion or exercise, as applicable, of the Convertible Notes and Warrants by
Splendid Days may cause significant dilution to our existing shareholders’ interest in our company.
Our ability to make scheduled payments of the principal of, to pay interest on or to refinance, our indebtedness, including
the Convertible Notes, depends on our future performance, which is subject to economic, financial, competitive and other factors
beyond our control. Our business may not generate cash flow from operations in the future sufficient to service our debt and make
necessary capital expenditures. If we are unable to generate such cash flow, we may be required to adopt one or more alternatives,
such as selling assets, restructuring debt or obtaining additional equity capital. We may not be able to engage in any of these activities
or engage in these activities on desirable terms, which could result in a default on our debt obligations. Incurrence of additional
indebtedness could also result in operating and financing covenants restricting our business operations. In addition, we cannot assure
you that any such future financing will be available to us in amounts or on terms acceptable to us, if at all. If we fail to obtain
sufficient financing to fund our capital needs, our business, financial condition and results or operations could be materially and
adversely affected.
6
The Convertible Notes are subject to redemption rights by holders upon a change of control of our company or an event of
default, and they contain covenants that may restrict our ability to declare dividends and our operational and financial flexibility.
In December 2015, we completed the issuance and sale of the Convertible Notes. Pursuant to the terms of the Convertible
Notes, if we undergo a change of control, holders of the Convertible Notes will be entitled to require us to redeem all or part of the
Convertible Notes, at a price payable in cash equal to 100% of the outstanding principal amount of the Convertible Notes, plus all
accrued and unpaid interests thereon, if any. The Convertible Notes define a “change of control” to include: (1) our company’s
consolidation with, or merger with or into, any other company, and vice versa; (2) our company disposing of all or substantially all of
its assets; (3) the adoption of a plan relating to the liquidation or dissolution of our company; or (4) Mr. Jun Zhu, our chairman and
chief executive officer, ceasing to directly or indirectly own 20% or more of the total outstanding and issued shares of our company
on a fully-diluted and as-converted basis. In addition, pursuant to the terms of the Convertible Notes, if there is a continuing event of
default, the holders will be entitled to declare any of the Convertible Notes immediately due and payable, and request redemption by
us at a price equal to the outstanding principal amount plus all accrued and unpaid interests thereon, if any. “Events of default” as
defined in the Convertible Notes include, among other things, an event of default of any indebtedness in the amount exceeding
US$500,000. If there is a change of control of our company and any event of default under the Convertible Notes, and our cash flows
and capital resources are insufficient to fund our debt service obligation, we may be forced to reduce or delay investments and capital
expenditures, or to sell assets, seek additional capital or restructure or refinance our indebtedness. These alternative measures may not
be successful and may not permit us to meet our scheduled debt service obligations, which could cause a material and adverse impact
on our operations and financial results.
In addition, the Convertible Notes contains covenants that may limit our financial and operating flexibility. The covenants
restrict our ability to, among other things, (1) make dividend or other distribution to our shareholders, and (2) sell or dispose of
certain assets, if such action would result in an event of default under the Convertible Notes. As a result of the covenants, our ability
to pay dividends or other distributions on our ordinary shares, including those represented by ADSs, may be limited. These covenants
could also restrict our ability to raise additional capital in the future through bank borrowings and debt and equity issuances and may
restrict our ability to engage in some transactions that we expect to be of benefit to us.
The Convertible Notes are secured by, among other things, a pledge of our 100% equity interest in The9 Computer, which may
result in our loss of control over Shanghai IT if we default under the Convertible Notes.
The Convertible Notes are secured by a pledge of our 100% equity interest in each of The9 Computer Technology
Consulting (Shanghai) Co., Ltd., or The9 Computer, and China The9 Interactive (Shanghai) Limited, or C9I Shanghai, our wholly
owned subsidiaries in China. Each of The9 Computer and C9I Shanghai holds a significant portion of our assets and operations in
China, and The9 Computer possesses the effective control over Shanghai IT, the affiliated PRC entity that operates our online game
business and other ICP related businesses, through a series of contractual arrangements. If we default under the Convertible Notes in
the future, the holders may enforce their claims against our equity interests in these two wholly-owned subsidiaries to satisfy our
obligations under the Convertible Notes. In such an event, the holders could gain ownership of all the equity interests in The9
Computer and C9I Shanghai, and, as a result, own and control these subsidiaries as well as Shanghai IT. As we conduct substantially
all of our operations in China through Shanghai IT, if we default under the Convertible Notes, we could lose control or ownership of
our assets and operations in China, which would materially and adversely affect our operations and financial results. In addition, the
Convertible Notes are also secured by a mortgage over our office building in Shanghai, which we currently use as our principal
executive offices.
Illegal game servers, unauthorized character enhancements and other infringements of our intellectual property rights, as well as
theft of in-game goods, could harm our business and reputation and materially and adversely affect our results of operation.
With the increase in the number of online game players in China, we face the risks of illegal game servers, unauthorized
character enhancements and other infringements of our intellectual property rights as well as the risk of theft of in-game goods
purchased by our customers. Our historical results of operations were materially and adversely affected by illegal game servers.
Although we have adopted a number of measures to address illegal server usage, misappropriation of our game server installation
software and the establishment of illegal game servers could harm our business and reputation and materially and adversely affect our
results of operations.
7
From time to time, we have detected a number of players who have gained an unfair advantage by installing tools that
fraudulently facilitate character progression. We have installed software patches designed to prevent unauthorized modifications to
our execution files. However, we cannot assure you that we will be able to identify and eliminate new illegal game servers,
unauthorized character enhancements or other infringements of our intellectual property rights in a timely manner, or at all. The
deletion of unauthorized character enhancements requires the affected players to restart with a new character from the starting level,
and this may cause some of these players to cease playing the game altogether. If we are unable to eliminate illegal servers,
unauthorized character enhancements or suffer other infringement of our intellectual property rights, our players’ perception of the
reliability of our games may be negatively impacted, which may reduce the number of players using our games, shorten the lifespan
of our games and adversely affect our results of operations.
Our business, financial condition and results of operations may be adversely affected by the downturn in the global or Chinese
economy.
Our operations are primarily conducted in China and a significant majority of our revenues are sourced from China.
Accordingly, our results of operations, financial condition and prospects are influenced by economic, political and legal
developments in China. Although the Chinese economy has grown significantly in the past decade, it has started to slow down since
2012. Economic conditions in China are sensitive to global economic conditions, as well as changes in domestic economic and
political policies and the expected or perceived overall economic growth rate in China. Subsequent to the financial crisis in 2008,
there has been considerable uncertainty over the long-term effects of the expansionary monetary and fiscal policies adopted by the
central banks and financial authorities of some of the world’s leading economies, including the United States and China. There have
been concerns over unrest and terrorist threats in the Middle East and Africa, which have resulted in volatility in oil and other
markets, and over the conflicts involving Ukraine and Syria. There have also been concerns on the relationship among China and
other Asian countries, which may result in or intensify potential conflicts in relation to territorial disputes. Any prolonged slowdown
in the global or Chinese economy the recurrence of any financial disruptions in any jurisdiction may significantly restrict our ability
to obtain financing in the capital markets or from financial institutions on commercially reasonable terms, or at all. In addition, our
customers may reduce, delay or cease discretionary spending on our products and services, while we may have difficulty expanding
our customer base fast enough, or at all, to offset the impact of decreased spending by our existing customers.
We face the risks of changing consumer preferences and uncertainty about market acceptance of our new products.
The online game industry is constantly evolving in China. Customer demand for and market acceptance of our online
games is subject to a high degree of uncertainty. Our future operating results will depend on numerous factors beyond our control.
These factors include, among others:
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the popularity of online games that we operate;
our ability to introduce new online games that are attractive to customers;
competition in the online games market;
general economic conditions, particularly economic conditions affecting discretionary consumer spending;
our ability to anticipate and timely and successfully adapt our product and service offerings constantly changing
customer tastes and preferences;
the availability of other forms of entertainment;
customer demand for our in-game items; and
critical reviews and public reception of our new products.
Our ability to plan for product development and distribution and promotional activities will be significantly affected by our
ability to anticipate and adapt to relatively rapid changes in consumer tastes and preferences. We currently offer online games
including MMOFPSs and mobile games, as well as TV games. A decline in the popularity of the types of games we offer could
adversely affect our business and prospects.
8
We may not be able to recover our market share and profitability as we operate in a highly competitive industry with numerous
competitors.
There are numerous online game operators in China. We expect that, given the relatively low entry barriers, more
companies will enter the online game industry in China and a wider range of online games will be introduced to the Chinese market.
Our competitors vary in size and include large companies, many of which have significantly greater financial, marketing and game
development resources and name recognition than we have, such as Tencent Holdings Limited, Shanda Games Limited, NetEase,
Inc., Giant Interactive Group Inc., Changyou.com Limited, Beijing Kunlun Tech Co., Ltd., Perfect World Co., Ltd. and NetDragon
Websoft Inc. As a result, we may not be able to devote the same degree of resources as our competitors do to designing, developing
or acquiring new games, undertaking extensive marketing campaigns, adopting aggressive pricing policies, paying high compensation
to game developers or compensating independent game developers. Our competitors may introduce new business methods from time
to time. If these new business methods are more attractive to customers than the business methods we currently use, our customers
may switch to our competitors’ games, and we may lose market share. We cannot assure you that we will be able to compete
successfully against new or existing competitors, or against new business methods implemented by them. In addition, the increasing
competition we anticipate in the online game industry may also reduce the number of our users or the growth rate of our user base or
reduce the game points spending for in-game premiums. All of these competitive factors could materially and adversely affect our
business, financial condition and results of operations and prevent us from recovering market share and profitability.
If we or our joint ventures fail to renew or acquire new online game licenses on favorable terms or at all, our future results of
operations and profitability may be materially impacted.
Despite our effort to develop and offer our own proprietary games, we and our joint ventures also seek to offer games
licensed from game licensors. In November 2015, our joint venture Oriental Shiny obtained an exclusive license from Smilegate to
publish and operate CrossFire 2 in China for an initial term of three years. Smilegate is currently in the process of developing
CrossFire 2. Historically, we have operated a number of games licensed from game licensors, all of which have expired or will soon
expire after the date of this annual report. There is no assurance that we or our joint ventures will be able to acquire new online game
licenses or favorable terms or at all, or that we or our joint ventures will be able to renew the game licenses upon their expiration.
We and our joint ventures need to renew existing licenses and may need to obtain new online game licenses, and any
failure to do so on favorable terms or at all may materially and adversely affect our business, financial condition and results of
operations. Online game developers may not grant or continue to grant licenses to us or our joint ventures due to commercial or other
reasons. If we or our joint ventures are unable to maintain a satisfactory relationship with the online game developers that have
licensed games to us or our joint ventures, resulting in licenses not being renewed or licenses being prematurely terminated, or should
any of these game developers either establish similar or more favorable relationships with our competitors in violation of their
contractual arrangements with us or our joint ventures, or otherwise, our operating results and our business would be harmed. We
cannot assure you that online game developers will renew their license agreements with us or our joint ventures, or grant us or our
joint ventures a license for any new online games that they will develop or make available to us or our joint ventures expansion packs
for existing games. Any failure to obtain or renew online game licenses from online game operators could harm our future results of
operations or the growth of our business.
If we and our joint venture Oriental Shiny are unable to successfully launch and operate CrossFire 2 in China, our future results
of operations may be materially and adversely affected.
We plan to invest a significant amount of financial and personnel resources in launching and operating CrossFire 2 in China,
which was licensed by Smilegate to our joint venture Oriental Shiny in November 2015 for an initial term of three years, subject to an
extension to five years. Oriental Shiny is a joint venture formed by Smilegate and Globe Wealthy Link Limited, or Globe Wealthy, a
wholly-owned subsidiary of System Link Corporation Limited, or System Link, our 50%-owned joint venture that we formed with
Qihoo 360. CrossFire 2 is the sequel of CrossFire, a first-person-shooter PC online game in China and Smilegate is the developer of
both games. Smilegate is currently in the process of developing CrossFire 2. There is no assurance that CrossFire 2 can be
successfully developed, localized, tested and launched, or that once CrossFire 2 is launched, Oriental Shiny will be able to continue to
operate the game at a profit or at all. The relevant Chinese governmental authorities may delay or deny the granting of the approvals
required for the open beta test, commercial launch or operation of CrossFire 2 due to the content of the game or other factors.
Furthermore, there is no assurance that CrossFire 2 will attract sufficient users and be commercially successful.
9
In addition, we have made and may continue to make significant financial commitments under the CrossFire 2 license
agreement. Pursuant to the CrossFire 2 license agreement, Oriental Shiny and Beijing Zhi’ao Network Technology Co., Ltd., or
Beijing Zhi’ao, the PRC entity established to operate CrossFire 2 in China, has paid an initial license fee of US$50 million to
Smilegate and may pay additional license fees of up to US$450 million subject to certain development milestones of CrossFire 2 and
extension of the term of the license. The payment of license fee is partly guaranteed by us based on our equity interest in System
Link. Oriental Shiny and Beijing Zhi’ao are also required to pay to Smilegate royalties, and Globe Wealthy is required to make
additional cash contributions to Oriental Shiny as may be necessary for publishing, operating and marketing CrossFire 2. See “Item 4.
Information on the Company—B. Business Overview—Arrangements with Smilegate regarding CrossFire 2.” If Oriental Shiny loses
the exclusive CrossFire 2 license for failure to meet its financial obligations or other reasons, or if Oriental Shiny is unable to
successfully launch and operate CrossFire 2 and generate revenues therefrom enough to offset our CrossFire 2-related costs and
expenses, our future results of operations will be adversely affected.
Future acquisitions may have an adverse effect on our ability to manage our business and our results of operations.
Selective acquisitions have been a part of our strategy to further expand our business in the past. However, the diversion of
our management’s attention away from our business and any difficulties encountered in the integration process could have an adverse
effect on our ability to manage our business. In addition, we have increasingly relied on our acquired subsidiaries to develop our own
proprietary games. For example, Red 5, a subsidiary acquired in 2010, has developed Firefall, which we launched in North America
and Europe in 2014 and expect to have a large-scale commercial launch in China in the second half of 2016. If our acquired
subsidiaries are unable to develop, launch and operate games that are commercially successful and appeal to game players, our
business, financial condition and results of operations may be materially and adversely affected.
There is no assurance that we will continue to have the necessary capital to conduct future acquisitions given the
significant net loss and negative operating cash flow we have been experiencing. In addition, our ability to grow through future
acquisitions, investments or organic means will also depend on the availability of suitable acquisitions and investment targets at an
acceptable cost as well as our ability to compete effectively to attract these candidates. We may face significant competition in
acquiring new businesses or companies, which may hinder the execution of our growth strategy. Future acquisitions or investments
could result in a potential dilutive issuance of equity securities or the incurrence of debt, contingent liabilities, impairment losses or
amortization expenses related to goodwill and other intangible assets, each of which could adversely affect our financial condition
and results of operations. The benefits of an acquisition or investment may also take considerable time to develop and we cannot be
certain that any particular acquisition or investment will produce its intended benefits. Future acquisitions would also expose us to
potential risks, including risks associated with the assimilation of new operations, technologies and personnel, unforeseen or hidden
liabilities, the diversion of resources from our existing businesses, sites and technologies, the inability to generate sufficient revenue
to offset the costs and expenses of acquisitions, and potential loss of, or harm to, our relationships with employees, customers,
licensors and other suppliers as a result of the integration of new businesses.
Future equity investments or establishment of joint ventures may have an adverse effect on our financial results and our ability to
manage our business.
From time to time, subject to the availability of the necessary financial resources, we make equity investments into
selected targets, such as online game developers, operators or application platforms, or establish joint venture with business partners,
to seek business growth opportunities. We may have limited power to direct or otherwise participate in the management of operations
and strategies of the companies in which we invest or the joint venture we establish. The diversion of our management’s attention
away from our business and any difficulties encountered in managing our interests in the respective investees or joint ventures could
have an adverse effect on our ability to manage our business. Any material disputes with our investment or joint venture partners and
existing shareholders may also require us to allocate significant corporate and other resources. For example, in August 2014, we
formed our joint venture company, System Link, with Qihoo 360, for publishing and operating Firefall for a five-year term in China.
In November 2015, our joint venture Oriental Shiny, which is majority-owned by System Link, obtained an exclusive license from
Smilegate to publish and operate CrossFire 2 in China for an initial term of three years, subject to an extension to five years.
Smilegate is currently in the process of developing CrossFire 2. If we fail to maintain our relationship with Qihoo 360 and fail to
identify an alternative partner with similar resources, we may no longer be able to continue to carry out the business conducted
through System Link, and our operating results may be materially and adversely affected. In addition, we may not recover our equity
investments if the companies in which we invest do not perform well and equity investments could result in the incurrence of
impairment losses, which could materially and adversely affect our results of operations.
10
Undetected programming errors or flaws in our games could harm our reputation or decrease market acceptance of our games,
which would materially and adversely affect our results of operations.
Our games may contain errors or flaws, which may only be discovered after their release, particularly as we launch new
games or introduce new features to existing games under tight time constraints. If our games contain programming errors or other
flaws, our customers may be less inclined to continue playing our games or to recommend our games to other potential customers,
and may switch to our competitors’ games. Undetected programming errors and game defects can disrupt our operations, adversely
affect the gaming experience of our users, harm our reputation, cause our customers to stop playing our games, divert our resources
and delay market acceptance of our games, any of which could materially and adversely affect our results of operations.
We may not be able to prevent others from infringing upon our intellectual property rights, which may harm our business and
expose us to litigation.
We regard our proprietary software, domain names, trade names, trademarks and similar intellectual properties as critical
to our business. Intellectual property rights and confidentiality protection in China may not be as effective as in the United States or
other countries. Monitoring and preventing the unauthorized use of proprietary technology is difficult and expensive. The steps we
have taken may be inadequate to prevent the misappropriation of our proprietary technology. Any misappropriation could have a
negative effect on our business and operating results. We may need to resort to court proceedings to enforce our intellectual property
rights in the future. Litigation relating to our intellectual property might result in substantial costs and diversion of resources and
management attention away from our business. See “—Risks Related to Doing Business in China—Uncertainties with respect to the
PRC legal system could adversely affect us.”
Any failure to maintain a stable and effective online payment system could adversely affect our business and results of operations.
Online payment systems in China are developing fast and a growing number of consumers are using such systems than in
previous years. We rely on our internally-developed online payment system, Pass9, for sales of our online game services to
consumers. Although our online payment systems are designed to support various third-party Internet payment channels in China, our
online payment systems may be disrupted by system failure, programming errors, computer hackers or any failure or disruption from
the Internet payment channels. See “Item 3. Key Information—D. Risk Factors—Risks Related to Our Company and Our Industry —
Our business may be harmed if our technology becomes obsolete or if our system infrastructure fails to operate effectively.” In
addition, we cannot assure you that we will maintain favorable relationships with third-party Internet payment channels. If we fail to
maintain a stable and favorable relationship with these channels, or otherwise fail to effectively maintain our online payment systems,
our business, financial condition and results of operations could be materially and adversely affected.
Any delay or failure by the online game platforms or distributors to successfully market or sell our products and services could
adversely affect our business and results of operations.
We primarily rely on game platforms and distributors to distribute, promote, market and sell our games in China and
overseas markets, such as North America, Europe and Southeast Asia. End users can purchase our virtual currencies and prepaid
cards through such game platforms and distributors. A substantial portion of our sales are carried out via such game platforms and
distributors. We do not have long-term agreements with any online game platforms or distributors. A delay or failure by the online
game platforms or distributors to successfully market or sell our prepaid cards or products may adversely affect our business and
results of operations. We cannot assure you that we will continue to maintain favorable relationships with the online game platforms
and distributors, and any failure to do so could materially and adversely affect our business and results of operations could be
materially and adversely affected.
11
We rely on services and licenses from third parties to carry out our businesses, and if there is any negative development in these
services or licenses, our end users may cease to use our products and services.
In addition to our online payment systems and distribution systems for which we significantly rely on third-party services,
we also rely on third-party services and licenses for our operations. For example, we rely on third-party licenses for some of the
software underlying our technology platform, and we rely on China Telecom’s Internet data centers to host our servers. See “Item 4.
Information on the Company—B. Business Overview—Pricing, Distribution and Marketing.” In addition, we expect to continue to
derive a considerable amount of our revenues from our licensed online games in the near term.
Any interruption or any other negative development in our ability to rely on these services and licenses, such as material
deterioration of quality of the third-party services or the loss of intellectual property relating to licenses held by our licensors, could
have a material and adverse impact on our business operations. In particular, our game licensors may be subject to intellectual
property rights claims with respect to the games or software licensed to us. If such licensors cannot prevail on the legal proceedings
brought against them, we could lose the right to use the licensed games or software. Furthermore, if our arrangements with any of
these third parties are terminated or modified against our interest, we may not be able to find alternative solutions on a timely basis or
on terms favorable to us. If any of these events occur, our end users may cease using our products and services, and our business,
financial condition and results of operations may be materially and adversely affected.
Unexpected network interruptions caused by system failures or other internal or external factors may lead to user attrition,
revenue reductions and may harm our reputation.
Any failure to maintain satisfactory performances, reliability, security and availability of our network infrastructure may
cause significant harm to our reputation and our ability to attract and maintain users. The system hardware for our operations is
located in several cities in China. We maintain our backup system hardware and operate our back-end infrastructure in Shanghai,
Beijing, Nanjing, and Taicang. Server interruptions, breakdowns or system failures in the cities where we maintain our servers and
system hardware, including failures that may be attributable to sustained power shutdowns, or other events within or outside our
control that could result in a sustained shutdown of all or a material portion of our services, could adversely impact our ability to
service our users.
Our network systems are also vulnerable to damage from computer viruses, fire, flood, earthquake, power loss,
telecommunications failures, computer hacking and similar events. We maintain property insurance policies covering our servers, but
do not have business interruption insurance.
Our business may be harmed if our technology becomes obsolete or if our system infrastructure fails to operate effectively.
The online game industry is subject to rapid technological change. We need to anticipate the emergence of new
technologies and games, assess their acceptance and make appropriate investments. If we are unable to do so, new technologies in
online game programming or operations could render our games obsolete or unattractive.
We use our internally developed Pass9 system and other software systems that support nearly all aspects of our billing and
payment transactions. Our business may be harmed if we are unable to upgrade our systems fast enough to accommodate future
traffic levels, avoid obsolescence or successfully integrate any newly developed or acquired technology with our existing systems.
Capacity constraints could cause unanticipated system disruptions and slower response times, affecting data transmission and game
play. These factors could, among other things, cause us to lose existing or potential customers and existing or potential game
development partners.
12
We have been and may be subject to future intellectual property rights claims or other claims, which could result in substantial
costs and diversion of our financial and management resources away from our business.
There is no assurance that our online games, including our mobile games, or other content posted on our websites, whether
proprietary or licensed from third parties, do not or will not infringe upon patents, valid copyrights or other intellectual property rights
held by third parties. We may be subject to legal proceedings and claims from time to time relating to the intellectual property of
others. For example, in May 2012, the People’s Supreme Court of China affirmed a judgment against us and other defendants in a
lawsuit filed by Beijing Founder Electronics Co., Ltd., which ruled that WoW client installation packages sold by us in 2007
contained fonts that infringed Beijing Founder Electronics Co., Ltd.’s intellectual property rights. Based on the People’s Supreme
Court’s judgment, we are required to compensate Beijing Founder Electronics Co., Ltd. an aggregate amount of RMB2.2 million. In
June 2013, Beijing No.1 People’s Intermediate Court issued a judgment against us in a lawsuit filed by Diego Maradona, a former
Argentina soccer player, which ruled that we infringed Maradona’s personal right by using his name and photos on our game
“Winning Goal,” a web and social game we previously operated, without proper authorization. We were required to compensate
Maradona an aggregate amount of RMB3.0 million and any accrued interests thereof for late payment. In February 2015, we entered
into a settlement agreement with the plaintiff for a total payment of RMB3.3 million (US$0.5 million) to settle the matter. See “Item
8. Financial Information—A. Consolidated Statements and Other Financial Information—Legal Proceedings.”
Some of our employees were previously employed at other companies, including our current and potential competitors. We
also intend to hire additional personnel to expand our product development and technical support teams. To the extent these
employees have been involved in research at our company similar to research in which they had been involved at their former
employers, we may become subject to claims that such employees have used or disclosed trade secrets or other proprietary
information of their former employers. In addition, our competitors may file lawsuits against us in order to gain an unfair competitive
advantage over us.
If any such claim arises in the future, litigation or other dispute resolution proceedings may be necessary to retain our
ability to offer our current and future games, which could result in substantial costs and diversion of our financial and management
resources. Furthermore, if we are found to have violated the intellectual property rights of others, we may be enjoined from using
such intellectual property, incur additional costs to license or develop alternative games and be forced to pay fines and damages, each
of which may materially and adversely affect our business and results of operations.
Our operating results may fluctuate due to various factors, and therefore may not be indicative of our future results.
Our operating results have experienced fluctuations from time to time and will likely continue to fluctuate in the future.
These fluctuations in operating results depend on a variety of factors, including the timing of new game launches, the expiration of
existing game licenses, and acquisition or disposal of subsidiaries. Other factors include the demand for our products and the products
of our competitors, the level of usage of illegal game servers, the level of usage of the Internet, the size and rate of growth of the
online game market and development and promotional expenses related to the introduction of new products. In addition, because our
game software is susceptible to unauthorized character enhancements, we may periodically delete characters that are enhanced with
unauthorized modifications. This has caused some affected customers to stop playing the respective game, which, in the aggregate,
may cause our operating results to fluctuate.
To a significant degree, our operating expenses are based on planned expenditures and our expectations regarding
prospective customer usage. Failure to meet our expectations could disproportionately and adversely affect our operating results in
any given period. As a result, our historical operating results may not necessarily be indicative of our future results.
Our business depends substantially on the continuing efforts of our senior executives, and our business may be severely disrupted
if we lose their services.
Our business and prospect depend heavily upon the continued services of our senior executives. We rely on their expertise
in business operations, technology support and sales and marketing and on their relationships with our shareholders and distributors.
We do not maintain key-man life insurance for any of our key executives. If one or more of our key executives are unable or
unwilling to continue in their present positions, we may not be able to replace them easily or at all. As a result, our business may be
severely disrupted, our financial condition and results of operations may be materially and adversely affected, and we may incur
additional expense to recruit and train personnel.
13
Each of our executive officers has entered into an employment agreement with us, which contains confidentiality and non-
competition provisions. If any disputes arise between our executive officers and us, we cannot assure you the extent to which any of
these agreements could be enforced in China, where these executive officers reside and hold most of their assets, in light of
uncertainties with the PRC legal system. See “Item 3. Key Information—D. Risk Factors —Risks Related to Doing Business in
China—Uncertainties with respect to the PRC legal system could adversely affect us.”
If we are unable to attract, train and retain key individuals and highly skilled employees, our business may be adversely affected.
Our business relies on our ability to hire and retain additional qualified employees, including skilled and experienced
online game developers. Since our industry is characterized by high demand and intense competition for talent, we may need to offer
higher compensation and other benefits in order to retain key personnel in the future. We cannot assure you that we will be able to
attract or retain the qualified game developers or other key personnel that we will need to achieve our business objectives.
PRC laws and regulations restrict foreign ownership of Internet content provision, Internet culture operation and Internet
publishing licenses, and substantial uncertainties exist with respect to the application and implementation of PRC laws and
regulations.
We are a Cayman Islands company and, as such, we are classified as a foreign enterprise under PRC laws. Various
regulations in China currently restrict foreign or foreign-owned entities from holding certain licenses required in China to provide
online game operation services over the Internet, including Internet content provision, or ICP, Internet culture operation and Internet
publishing licenses. In light of such restrictions, we primarily rely on Shanghai IT, one of our affiliated PRC entities, to hold and
maintain the licenses necessary for the operation of our online games in China.
In July 2006, the Ministry of Information Industry (which has subsequently been reorganized as the Ministry of Industry
and Information Technology), or MIIT, issued a notice entitled “Notice on Strengthening Management of Foreign Investment in
Operating Value-Added Telecommunication Services,” or the MII Notice, which prohibits ICP license holders from leasing,
transferring or selling a telecommunications business operating license to foreign investors in any form, or providing resources, sites
or facilities to any foreign investors for their illegal operation of a telecommunications business in China. The notice also requires
that ICP license holders and their shareholders directly own the domain names and trademarks used by such ICP license holders in
their daily operations. The notice further requires each ICP license holder to have the necessary facilities for its approved business
operations and to maintain such facilities in the regions covered by its license. In addition, all value-added telecommunication service
providers are required to maintain network and information security in accordance with the standards set forth under relevant PRC
regulations. The local authorities in charge of telecommunications services are required to ensure that existing ICP license holders
conduct a self-assessment of their compliance with the MII Notice and submit status reports to MIIT before November 1, 2006. Since
the MII Notice was issued, we have transferred to Shanghai IT all of the domain names used in our daily operations and certain
trademarks used in our daily operations, as required under the MII Notice. All relevant transfers have been completed and relevant
approvals have been obtained.
In September 2009, the General Administration of Press and Publication, Radio, Film and Television, or GAPPRFT
(formerly known as the General Administration of Press and Publication, or GAPP), promulgated the Circular Regarding the
Implementation of the Department Reorganization Regulation by State Council and Relevant Interpretation by State Commission
Office for Public Sector Reform to Further Strengthen the Administration of Pre-approval on Online Games and Approval on Import
Online Games, or the GAPP Circular, which provides that foreign investors shall not control or participate in PRC online game
operation businesses indirectly or in a disguised manner by establishing joint venture companies or entering into relevant agreements
with, or by providing technical supports to, such PRC online game operation companies, or by inputting the users’ registration,
account management or game card consumption directly into the interconnected gaming platform or fighting platform controlled or
owned by the foreign investor. It is not clear whether the regulatory authority of GAPPRFT applies to the regulation of ownership
structures of online game companies based in China and online game operation in China. Other government agencies that have
regulatory jurisdiction over the online game operations in China, such as the Ministry of Culture and MIIT, did not join GAPP in
issuing the GAPP Circular. To date, the GAPPRFT has not issued any interpretation of the GAPP Circular. It is not yet clear how this
GAPP Circular will be implemented.
14
Subject to the interpretation and implementation of the GAPP Circular, the ownership structure and the business operation
models of our PRC subsidiaries and affiliated PRC entities comply with all applicable PRC laws, rules and regulations, and no
consent, approval or license is required under any of the existing laws and regulations of China for their ownership structure and
business operation models except for those which we have already obtained or which would not have a material adverse effect on our
business or operations as a whole. There are, however, substantial uncertainties regarding the interpretation and application of current
or future PRC laws and regulations. Accordingly, we cannot assure you that PRC government authorities will ultimately take a view
that is consistent with the opinion of our PRC legal counsel.
For example, the Ministry of Commerce, or MOFCOM, promulgated the Rules of Ministry of Commerce on
Implementation of Security Review System of Mergers and Acquisitions of Domestic Enterprises by Foreign Investors in August
2011, or the MOFCOM Security Review Rules, to implement the Notice of the General Office of the State Council on Establishing
the Security Review System for Mergers and Acquisitions of Domestic Enterprises by Foreign Investors promulgated on February 3,
2011, or Circular No. 6. The MOFCOM Security Review Rules came into effect on September 1, 2011 and replaced the Interim
Provisions of the Ministry of Commerce on Matters Relating to the Implementation of the Security Review System for Mergers and
Acquisitions of Domestic Enterprises by Foreign Investors promulgated by MOFCOM in March 2011. According to these circulars
and rules, a security review is required for mergers and acquisitions by foreign investors having “national defense and security”
concerns and mergers and acquisitions by which foreign investors may acquire the “de facto control” of domestic enterprises having
“national security” concerns. In addition, when deciding whether a specific merger or acquisition of a domestic enterprise by foreign
investors is subject to the security review, MOFCOM will look into the substance and actual impact of the transaction. The
MOFCOM Security Review Rules further prohibit foreign investors from bypassing the security review requirement by structuring
transactions through proxies, trusts, indirect investments, leases, loans, control through contractual arrangements or offshore
transactions. There is no explicit provision or official interpretation stating that our online game operation services falls into the scope
subject to the security review, and there is no requirement for foreign investors in those merger and acquisition transactions already
completed prior to the promulgation of Circular No. 6 to submit such transactions to MOFCOM for security review. As we have
already obtained the “de facto control” over our affiliated PRC entities prior to the effectiveness of these circulars and rules, we do
not believe we are required to submit our existing contractual arrangement to MOFCOM for security review. However, we are
advised by our PRC legal counsel that, as these circulars and rules are relatively new and as there is a lack of clear statutory
interpretation on the implementation of the same, there is no assurance that MOFCOM will have the same view as we do when
applying these national security review-related circulars and rules.
We have been further advised by our PRC counsel that if we, any of our PRC subsidiaries or affiliated PRC entities are
found to be in violation of any existing or future PRC laws or regulations, including the MII Notice and the GAPP Circular, or fail to
obtain or maintain any of the required permits or approvals, the relevant PRC regulatory authorities, would have broad discretion in
dealing with such violations, including:
•
•
•
•
revoking the business and operating licenses of Shanghai IT;
confiscating our income or the income of Shanghai IT;
discontinuing or restricting the operations of any related-party transactions among us and Shanghai IT;
limiting our business expansion in China by way of entering into contractual arrangements;
15
•
•
•
imposing fines or other requirements with which we may not be able to comply;
requiring Shanghai IT or us to restructure our corporate structure or operations; or
requiring Shanghai IT or us to discontinue any portion or all of our operations related to online games.
The imposition of any of these penalties could result in a material and adverse effect on our ability to conduct our business
and on our results of operations. If any of these penalties results in our inability to direct the activities of Shanghai IT that most
significantly impact its economic performance, and/or our failure to receive the economic benefits from Shanghai IT, we may not be
able to consolidate Shanghai IT in our consolidated financial statements in accordance with U.S. GAAP.
We rely on contractual arrangements for our operations and operating licenses in China, which may not be as effective in
providing operational control as direct ownership.
Because the PRC government restricts our ownership of ICP, Internet culture operation and Internet publishing businesses
in China, we primarily depend on Shanghai IT, in which we have no ownership interest, to operate our online game business and
other ICP related businesses, and hold and maintain the requisite licenses. We have relied and expect to continue to rely on
contractual arrangements to obtain effective control over Shanghai IT. Such contractual arrangements may not be as effective as
direct ownership in providing us with control over the Shanghai IT. From the legal perspective, if Shanghai IT fails to perform its
obligations under the contractual arrangements, we may have to incur substantial costs and spend other resources to enforce such
arrangements, and rely on legal remedies under PRC law, including seeking specific performance or injunctive relief and claiming
damages. For example, if the shareholders of Shanghai IT were to refuse to transfer their equity interests in Shanghai IT to us or our
designee when we exercise the call option pursuant to the Call Option Agreement, or if such shareholders otherwise act in bad faith
toward us, we may have to take legal action to compel it to fulfill their contractual obligations, which could be time consuming and
costly.
These contractual arrangements are governed by PRC law and provide for the resolution of disputes through arbitration in
the PRC. The legal environment in the PRC is not as developed as in some other jurisdictions, such as the United States. As a result,
uncertainties in the PRC legal system could limit our ability to enforce these contractual arrangements. In particular, a recently
released draft version of the PRC Foreign Investment Law from the MOFCOM may have a substantial impact on our corporate
structure as well as our business operations. See “—Substantial uncertainties exist with respect to the enactment timetable,
interpretation and implementation of the draft PRC Foreign Investment Law and how it may impact the viability of our current
corporate structure, corporate governance and business operations.” We have historically derived significant revenues from Shanghai
IT. For the years ended December 31, 2013, 2014 and 2015, Shanghai IT contributed 82.6%, 66.4% and 74.1%, respectively, of our
total revenues. In the event we are unable to enforce the contractual arrangements, we may not be able to have the power to direct the
activities that most significantly affect the economic performance of Shanghai IT, and our ability to conduct our business may be
negatively affected, and we may not be able to consolidate the financial results of Shanghai IT into our consolidated financial
statements in accordance with U.S. GAAP.
We believe that our option to purchase all or part of the equity interests in Shanghai IT, when and to the extent permitted
by PRC law, or request any existing shareholder of Shanghai IT to transfer all or part of the equity interest in Shanghai IT to another
PRC person or entity designated by us at any time in our discretion, and the rights under the Shareholder Voting Proxy Agreement
that the shareholders of Shanghai IT have granted to us, effectively enable us to have the ability to cause the related contractual
arrangements to be renewed when needed. However, if we are not able to effectively enforce these agreements or otherwise renew the
relevant agreements when they expire, our ability to receive the economic benefits of Shanghai IT may be adversely affected.
16
Our ability to enforce the Equity Pledge Agreements between us and the shareholders of Shanghai IT may be subject to
limitations based on PRC laws and regulations.
Pursuant to the Equity Pledge Agreements with the shareholders of Shanghai IT, such shareholders agreed to pledge their
equity interests in Shanghai IT to secure their performance under the relevant contractual arrangements. The equity pledges of
Shanghai IT under these Equity Pledge Agreements have been registered with the relevant local administration for industry and
commerce pursuant to the new PRC Property Rights Law. According to the PRC Property Rights Law and PRC Guarantee Law, the
pledgee and the pledgor are prohibited from making an agreement prior to the expiration of the debt performance period to transfer
the ownership of the pledged equity to the pledgee when the obligor fails to pay the debt due. However, under the PRC Property
Rights Law, when an obligor fails to pay its debt when due, the pledgee may choose to either conclude an agreement with the pledgor
to obtain the pledged equity or seek payments from the proceeds of the auction or sell-off of the pledged equity. If Shanghai IT or its
shareholders fail to perform their obligations secured by the pledges under the Equity Pledge Agreements, one remedy in the event of
default under the agreements is to require the pledgors to sell the equity interests of Shanghai IT in an auction or private sale and
remit the proceeds to our wholly owned subsidiaries in China, net of related taxes and expenses. Such an auction or private sale may
not result in our receipt of the full value of the equity interests in Shanghai IT. We consider it very unlikely that the public auction
process would be undertaken since, in an event of default, our preferred approach is to ask The9 Computer, our PRC wholly owned
subsidiary and a party to the Call Option Agreement, to replace or designate another PRC person or entity to replace the existing
shareholders of Shanghai IT pursuant to the direct transfer option we have under the option agreement.
In addition, in the registration forms of the local branch of State Administration for Industry and Commerce for the pledges
over the equity interests under the Equity Pledge Agreements, the amount of registered equity interests in Shanghai IT pledged to us
was stated as RMB23.0 million, which represent 100% of the registered capital of Shanghai IT. The Equity Pledge Agreements with
the shareholders of Shanghai IT provide that the pledged equity interest shall constitute continuing security for any and all of the
indebtedness, obligations and liabilities under all of the contractual arrangements and the scope of pledge shall not be limited by the
amount of the registered capital of Shanghai IT. However, it is possible that a PRC court may take the position that the amount listed
on the equity pledge registration forms represents the full amount of the collateral that has been registered and perfected. If this is the
case, the obligations that are supposed to be secured under the Equity Pledge Agreements in excess of the amount listed on the equity
pledge registration forms could be determined by the PRC court as unsecured debt, which takes last priority among creditors and
often does not have to be paid back at all. We do not have agreements that pledge the assets of Shanghai IT for the benefit of us.
Our contractual arrangements with our affiliated entities may result in adverse tax consequences to us.
We could face material and adverse tax consequences if the PRC tax authorities determine that our contractual
arrangements with Shanghai IT and our other affiliated entities were not made on reasonable or arm’s length commercial terms or
otherwise. If this were to occur, they may adjust our income and expenses for PRC tax purposes in the form of a transfer pricing
adjustment. A transfer pricing adjustment could result in a reduction, for PRC tax purposes, of costs and expenses recorded by our
affiliated entities, which could adversely affect us by: (i) increasing the tax liability of our affiliated entities without reducing our
other PRC subsidiaries’ tax liability, which could further result in late payment fees and other penalties to our affiliated entities for
underpaid taxes; or (ii) limiting the abilities of our affiliated entities to maintain preferential tax treatments and other financial
incentives.
We may not be able to get approval for renewing our current foreign games, or for licensing new foreign games, if the PRC
regulatory authorities promote a policy of domestic online or mobile game development and tighten approval criteria for online or
mobile game imports.
We license and operate foreign games and may continue to do so in the near future. In the past, such foreign games mainly
included MMORPGs or casual games. With mobile social gaming being one of our new businesses, we also license foreign mobile
games. Since 2004, relevant government authorities have promulgated several circulars, according to which the development of
domestically developed online games, including mobile games, will be strategically supported by the PRC government. For example,
in July 2005, MIIT and the Ministry of Culture issued the Opinion on Development and Management of Online Games, or the
Opinion. The Opinion provided that domestic software development companies, network service providers and content providers will
be encouraged, guided and supported to develop and promote self-developed and self-owned online games so that such games can
take up a leading position in the domestic market and expand into the international market.
17
The government will also encourage the development of derivative products to domestic online games. In support of this
policy, GAPPRFT may tighten approval criteria for online game imports in an effort to protect the development of domestic online
game enterprises, as well as to limit the influence of foreign culture on Chinese youth. If GAPPRFT implements such rules and
policies, we may not be able to get approval for renewing our current foreign game licenses or for licensing new foreign games, and
our business, financial condition and results of operations may be materially and adversely affected.
Failure to obtain or renew approvals or filings for online games and mobile games we operate may adversely affect our operations
or subject us to penalties.
The Ministry of Culture has promulgated laws and regulations that require, among other things, (i) the review and prior
approval of all new online games licensed from foreign game developers and related license agreements, (ii) the review of patches
and updates with substantial changes of games which have already been approved, and (iii) the filing of domestically developed
online games. Furthermore, online games, regardless of whether imported or domestic, will be subject to content review and approval
by GAPPRFT prior to the commencement of games operations in China. Failure to obtain or renew approvals or complete filings for
online games, including mobile games, may materially delay or otherwise affect a game operator’s plan to launch new games, and the
operator may be subject to fines, the restriction or suspension of operations of the related games or revocation of licenses in the event
that the relevant governmental authority believes that the violation is severe.
We obtained all the necessary approvals from, and completed the necessary filings with, the Ministry of Culture and GAPP
for operations of applicable games. Consistent with the general practice of the mobile and TV game industry in China, we have not
yet completed filings with the Ministry of Culture and GAPPRFT for our mobile and TV games before we commenced our
operations. From time to time, we also rely on certain third party licensors of domestically developed online games to obtain
approvals and complete filings with the PRC regulatory authorities. If we or any such third party licensors fail to obtain the required
approvals or complete the filings, we may not be able to continue the operation of such games. If any such negative event occurs, our
business, financial condition and results of operations may be materially and adversely affected.
The principal shareholders of our affiliated PRC entities have potential conflicts of interest with us, which may adversely affect
our business.
Zhimin Lin and Wei Ji, two of our employees, are the principal shareholders of Shanghai IT, one of our affiliated entities.
Thus, there may be conflicts of interest between their respective duties to our company as employees and their respective shareholder
interests in these affiliated PRC entities. We cannot assure you that when conflicts of interest arise, these persons will act in our best
interests or that conflicts of interests will be resolved in our favor. These persons could violate their legal duties, including duties
under their non-competition or employment agreements with us, by engaging in activities that are not in the best interest in our
company, such as diverting business opportunities from us. In any such event, we would have to rely on the PRC legal system to
enforce these agreements. Any legal proceeding could result in the disruption of our business, diversion of our resources and the
incurrence of substantial costs. See “—Risks Related to Doing Business in China—Uncertainties with respect to the PRC legal
system could adversely affect us.”
Our subsidiaries in China are subject to restrictions on paying dividends or making other payments.
From time to time, we may rely on dividends paid by our subsidiaries in China to fund our operations, such as paying
dividends to our shareholders or meeting obligations under any indebtedness incurred by us or our overseas subsidiaries. Current PRC
regulations restrict our subsidiaries in China from paying dividends in the following two principal aspects: (i) our subsidiaries in
China are only permitted to pay dividends out of their respective after-tax profits, if any, determined in accordance with PRC
accounting standards and regulations, and (ii) these entities are required to allocate at least 10% of their respective after-tax profits
each year, if any, to fund statutory reserve funds until the cumulative total of the allocated reserves reaches 50% of registered capital,
and a portion of their respective after-tax profits to their staff welfare and bonus reserve funds as determined by their respective
boards of directors or shareholders. These reserves are not distributable as dividends. See “Item 4. Information on the Company—B.
Business Overview—Government Regulations.” Further, if these entities incur debt on their behalf in the future, the instruments
governing such debt may restrict their ability to pay dividends or make other payments. Our inability to receive dividends or other
payments from our PRC subsidiaries may adversely affect our ability to continue to grow our business and make cash or other
distributions to the holders of our ordinary shares and ADSs. In addition, failure to comply with relevant State Administration of
Foreign Exchange, or SAFE, regulations may restrict the ability of our subsidiaries to make dividend payments to us. See “—Risks
Related to Doing Business in China—PRC regulations relating to the establishment of offshore special purpose companies by PRC
residents may subject our PRC resident shareholders or us to penalties and fines, and limit our ability to inject capital into our PRC
subsidiaries, limit our subsidiaries’ ability to increase their registered capital, distribute profits to us, or otherwise adversely affect
us.”
18
We could be liable for breaches of security on our websites and fraudulent transactions by users of our websites.
Currently, a portion of our transactions are conducted through our websites. In such transactions, secure transmission of
confidential information (such as customers’ credit card numbers and expiration dates, personal information and billing addresses)
over public networks is essential to maintain consumer confidence. Our current security measures may not be adequate to safeguard
against fraudulent transactions. Security breaches could expose us to litigation and possible liability for failing to secure confidential
customer information and could harm our reputation and ability to attract customers.
Existing major shareholders have substantial control over us and could delay or prevent a change in corporate control.
Incsight Limited, or Incsight, a company wholly-owned by Jun Zhu, our chairman and chief executive officer, and Bosma
Limited, or Bosma, the two largest shareholders of our company, collectively own a significant percentage of our outstanding
ordinary shares. Incsight and Bosma have entered into a voting agreement to vote together with respect to the election of our
directors. See “Item 6. Directors, Senior Management and Employees—C. Board Practices—Voting Agreement.” As a result, these
shareholders will continue to exert significant control over all matters requiring shareholder approval, including but not limited to, the
election of directors and approval of significant corporate transactions. This voting power could delay or prevent an acquisition of our
company on terms that other shareholders may desire. In addition, the rights of minority shareholders and the fiduciary duties of
directors in the Cayman Islands may not be as extensive as those in the United States or elsewhere, and the ability to assert
shareholder rights may be comparatively limited.
The PRC income tax laws may increase our tax burden or the tax burden on the holders of our shares or ADSs, and tax benefits
available to us may be reduced or repealed, causing the value of your investment in us to decrease .
Our subsidiaries and affiliated entities in the PRC are subject to enterprise income tax, or EIT, on the taxable income as
reported in their respective statutory financial statements adjusted in accordance with the Enterprise Income Tax Law of the People’s
Republic of China, or EIT Law, which was approved by the National People’s Congress on March 16, 2007. The EIT Law went into
effect as of January 1, 2008, which unified the tax rate generally applicable to both domestic and foreign-invested enterprises in the
PRC. Our subsidiaries and affiliated entities in the PRC are generally subject to EIT at a statutory rate of 25%. Shanghai IT, our
affiliated entity which holds a High and New Technology Enterprise, or HNTE, qualification is entitled to enjoy a 15% preferential
EIT rate. However, we cannot assure you that Shanghai IT will meet these criteria and continue to be qualified as an HNTE if we
apply to the tax authorities in the future.
Moreover, unlike the tax regulations effective before 2008, which specifically exempted withholding taxes on dividends
payable to non-PRC investors from foreign-invested enterprises in the PRC, the EIT Law and its implementation rules provide that a
withholding income tax rate of 10% will be applicable to dividends payable by Chinese companies to non-PRC-resident enterprises
unless otherwise exempted or reduced according to treaties or arrangements between the PRC central government and the
governments of other countries or regions. While the Tax Agreement between the PRC and Hong Kong provides dividends paid by a
foreign-invested enterprise in the PRC to its corporate shareholder, which is considered a Hong Kong tax resident, will be subject to
withholding tax at the rate of 5% of total dividends, this is limited to instances where the corporate shareholder directly holds at least
25% of the shares of the company that is to pay dividends for at least twelve consecutive months immediately prior to receiving the
dividends and meets certain other criteria prescribed by the relevant regulations. Entitlement to a lower tax rate on dividends
according to tax treaties or arrangements between the PRC central government and governments of other countries or regions is
further subject to approval of the relevant tax authority.
19
Furthermore, the State Administration of Taxation, or SAT, promulgated the Notice on How to Understand and Determine
the Beneficial Owners in Tax Agreement in October 2009, or Circular 601, which provides guidance for determining whether a
resident of a contracting state is the “beneficial owner” of an item of income under China’s tax treaties and tax arrangements.
According to Circular 601, a beneficial owner generally must be engaged in substantive business activities. An agent or conduit
company will not be regarded as a beneficial owner and, therefore, will not be qualified for treaty benefits. A conduit company
normally refers to a company that is set up for the purpose of avoiding or reducing taxes or transferring or accumulating profits. In
June 2012, SAT further promulgated the Announcement on Determining the Beneficial Owners in Tax Agreement, or Circular 30,
which provides that the tax authorities shall make the decision based on a comprehensive consideration of all determining factors
provided in Circular 601 rather than the status of a single determining factor. We cannot assure you that any dividends to be
distributed by our subsidiaries to us or by us to our non-PRC shareholders and ADS holders, whose jurisdiction of incorporation has a
tax treaty with China providing a different withholding arrangement, will be entitled to the benefits under the relevant withholding
arrangement.
In addition, the EIT Law deems an enterprise established offshore but having its management organ in the PRC as a
“resident enterprise” that will be subject to PRC tax at the rate of 25% of its global income. Under the Implementation Rules of the
EIT Law, the term “management organ” is defined as “an organ which has substantial and overall management and control over the
manufacturing and business operation, personnel, accounting, properties and other factors.” On April 22, 2009, the SAT further
issued a notice regarding recognizing an offshore-established enterprise controlled by PRC shareholders as a resident enterprise
according to its management organ, or Circular 82. According to Circular 82, a foreign enterprise controlled by a PRC company or a
PRC company group shall be deemed a PRC resident enterprise, if (i) the senior management and the core management departments
in charge of its daily operations are mainly located and function in the PRC; (ii) its financial decisions and human resource decisions
are subject to the determination or approval of persons or institutions located in the PRC; (iii) its major assets, accounting books,
company seals, minutes and files of board meetings and shareholders’ meetings are located or kept in the PRC; and (iv) more than
half of the directors or senior management with voting rights reside in the PRC. On July 27, 2011, SAT issued the Administrative
Measures of Enterprise Income Tax of Chinese-Controlled Offshore Incorporated Resident Enterprises (Trial), or SAT Bulletin 45,
which further clarified the detailed procedures for determining resident status under Circular 82, competent tax authorities in charge
and post-determination administration of such resident enterprises. Although our offshore companies are not controlled by any PRC
company or PRC company group, we cannot assure you that we will not be deemed to be a “resident enterprise” under the EIT Law
and thus be subject to PRC EIT on our global income.
According to the EIT Law and its implementation rules, dividends are exempted from income tax if such dividends are
received by a resident enterprise on equity interests it directly owns in another resident enterprise. However, foreign corporate holders
of our shares or ADSs may be subject to taxation at a rate of 10% on any dividends received from us or any gains realized from the
transfer of our shares or ADSs if we are deemed to be a resident enterprise or if such income is otherwise regarded as income from
“sources within the PRC.” The EIT Law empowers the PRC State Council to enact appropriate implementing rules and measures and
there is no guarantee that we or our subsidiaries will be entitled to any of the preferential tax treatments. Nor can we assure you that
the tax authorities will not, in the future, discontinue any of our preferential tax treatments, potentially with retroactive effect. Any
significant increase in the EIT rate under the EIT Law applicable to our PRC subsidiaries and affiliated entities, or the imposition of
withholding taxes on dividends payable by our subsidiaries to us, or an EIT levy on us or any of our subsidiaries or affiliated entities
registered outside the PRC, or dividends or capital gains received by our shareholders due to shares or ADSs held in us will have a
material adverse impact on our results of operations and financial conditions and the value of investments in us.
20
We are required to pay value added tax as a result of tax reforms in various regions in China and we may be subject to similar tax
treatments elsewhere in China.
On November 16, 2011, the Ministry of Finance and the SAT jointly issued the Circular on the Pilot Program for the
Collection of Value Added Tax Instead of Business Tax, or Circular 110, and the Circular on the Pilot Program for the Collection of
Value Added Tax Instead of Business Tax in the Transportation and Certain Modern Service Sectors in Shanghai, or Circular 111,
which became effective on January 1, 2012. Pursuant to Circular 110 and Circular 111, a tax reform pilot program came into effect in
Shanghai, which was chosen by the PRC government as the first pilot city for such reform. Starting from January 1, 2012, companies
which are designated by Shanghai local tax authorities as operating in certain modern service sectors are required to pay value added
tax, or VAT, in lieu of business tax. On July 31, 2012, the Ministry of Finance and the SAT jointly issued the Circular on the Pilot
Program for the Collection of Value Added Tax Instead of Business Tax in the Transportation and Certain Modern Service Sectors in
Eight Cities and Provinces such as Beijing, or Circular 71, which further extended areas subject to the pilot program to cover eight
more provinces. On December 12, 2013, the Ministry of Finance and the SAT jointly issued the Interim Implementation Rules on the
Pilot Program for the Collection of Value Added Tax Instead of Business Tax and a series of other rules, which annulled the
preceding trial rules and extended applicable areas of the pilot program to the whole country. As a result of such Implementation
Rules, some of our services provided by Shanghai IT and The9 Computer are subject to VAT at the rate of 6%. Shanghai IT and The9
Computer, as General VAT Payers under the applicable tax regulations, may reduce their VAT payable amount by the VAT which
they paid in connection with its purchasing activities, or its Input VAT. Certain services provided by Shanghai The9 Education
Technology Co., Ltd. (formerly named as Shanghai The9 Education Software Technology Co., Ltd.), or The9 Education, and our
other PRC subsidiaries or affiliated PRC entities shall be subject to VAT at the rate of 3%, and these companies as Small-scale VAT
Payers under the applicable tax regulations may not reduce their VAT payable by their Input VAT. There is significant uncertainty
relating to the interpretation and enforcement of such circulars by the national and the local tax authorities and other relevant
authorities. Beginning from August 1, 2013, the VAT reform was expanded to all regions in the PRC. As a result, we may be subject
to more unfavorable tax treatment with respect to our business operations as a result of the VAT reform, and our business, financial
condition and results of operations could be materially and adversely affected.
On March 23, 2016, the Ministry of Finance and the SAT jointly issued the Circular on the Pilot Program for Overall
Implementation of the Collection of Value Added Tax Instead of Business Tax, or Circular 36, which will take effect on May 1, 2016.
Pursuant to Circular 36, all companies operating in construction, real estate, finance, modern service or other sectors which were
required to pay business tax are required to pay VAT in lieu of business tax. As a result of Circular 36, the services provided by
Shanghai IT, The9 Computer, C9I Shanghai, Shanghai Fire Wing and The9 Education as general VAT payers will be subject to VAT
at the rate of 6%, and the services provided by our other PRC subsidiaries and affiliated PRC entities as small-scale VAT payers will
be subject to VAT at the rate of 3%.
Strengthened scrutiny over acquisition transactions by the PRC tax authorities may have a negative impact on our acquisition
strategy.
In connection with the EIT Law, the Ministry of Finance and SAT jointly issued, on April 30, 2009, the Notice on Issues
Concerning Process of Enterprise Income Tax in Enterprise Restructuring Business, or Circular 59. On December 10, 2009, the SAT
issued the Notice on Strengthening the Management on Enterprise Income Tax for Non-resident Enterprises Equity Transfer, or
Circular 698. Both Circular 59 and Circular 698 became effective retroactively on January 1, 2008. Under the two circulars, non-
PRC-resident enterprises may be subject to income tax on capital gains generated from their transfers of equity interests in PRC
resident enterprises. The PRC tax authorities have the discretion under Circular 59 and Circular 698 to make adjustments to the
taxable capital gains based on the difference between the fair value of the equity interests transferred and the cost of the investment.
In addition, by promulgating and implementing the circulars, the PRC tax authorities have strengthened their scrutiny over the direct
or indirect transfer of equity interests in a PRC resident enterprise by a non-PRC-resident enterprise. For example, Circular 698
specifies that the PRC SAT is entitled to redefine the nature of an equity transfer where offshore vehicles are interposed for tax-
avoidance purposes and without reasonable commercial purpose.
21
On February 3, 2015, the SAT issued the Notice on Several Issues regarding Enterprise Income Tax for Indirect Property
Transfer by Non-resident Enterprises, or SAT Circular 7, which further specifies the criteria for judging reasonable commercial
purpose, and the legal requirements for the voluntary reporting procedures and filing materials in the case of indirect property
transfer. SAT Circular 7 has listed several factors to be taken into consideration by tax authorities in determining whether an indirect
transfer has a reasonable commercial purpose. However, despite these factors, an indirect transfer satisfying all the following criteria
shall be deemed to lack reasonable commercial purpose and be taxable under the PRC laws: (i) 75% or more of the equity value of
the intermediary enterprise being transferred is derived directly or indirectly from the PRC taxable properties; (ii) at any time during
the one year period before the indirect transfer, 90% or more of the asset value of the intermediary enterprise (excluding cash) is
comprised directly or indirectly of investments in the PRC, or 90% or more of its income is derived directly or indirectly from the
PRC; (iii) the functions performed and risks assumed by the intermediary enterprise and any of its subsidiaries that directly or
indirectly hold the PRC taxable properties are limited and are insufficient to prove their economic substance; and (iv) the foreign tax
payable on the gains derived from the indirect transfer of the PRC taxable properties is lower than the potential PRC tax on the direct
transfer of such assets. Nevertheless, the indirect transfer falling into the scope of the safe harbor under SAT Circular 7 may not be
subject to PRC tax and such safe harbor includes qualified group restructuring, public market trading and tax treaty exemptions.
Under SAT Circular 7, the entities or individuals obligated to pay the transfer price to the transferor shall be the withholding agent
and shall withhold the PRC tax from the transfer price. If the withholding agent fails to do so, the transferor shall report to and pay
the PRC tax to the PRC tax authorities. In case neither the withholding agent nor the transferor complies with the obligations under
SAT Circular 7, other than imposing penalties such as late payment interest on the transferors, the tax authority may also hold the
withholding agent liable and impose a penalty of 50% to 300% of the unpaid tax on the withholding agent, provided that such penalty
imposed on the withholding agent may be reduced or waived if the withholding agent has submitted the relevant materials in
connection with the indirect transfer to the PRC tax authorities in accordance with SAT Circular 7.
Since we may pursue acquisition as one of our growth strategies, and have conducted and may conduct acquisitions
involving complex corporate structures, the PRC tax authorities may, at their discretion, adjust the capital gains and impose tax return
filing obligations on us or request us to submit additional documentation for their review in connection with any of our acquisitions,
thus causing us to incur additional acquisition costs.
We have adopted a shareholders rights plan, which, together with the other anti-takeover provisions of our articles of association,
could discourage a third party from acquiring us, which could limit our shareholders’ opportunity to sell their shares, including
ordinary shares represented by our ADSs, at a premium.
On January 8, 2009, our board of directors adopted a shareholder rights plan. Under the rights plan, one right was
distributed with respect to each of our ordinary shares outstanding at the close of business on January 22, 2009. In the event that,
subject to limited exceptions, a person or group obtains beneficial ownership of 15% or more of our voting securities (including by
acquisition of our ADSs representing ordinary shares), or enters into an acquisition transaction without the approval of our board of
directors, such person or group will become the acquiring person under the plan. As a result, these rights will entitle the holders, other
than the acquiring person, to purchase upon the exercise of such right the number of our ordinary shares having a market value of two
times the then current purchase price associated with the right. For example, at a purchase price of US$19.50 per right, each right not
owned by an acquiring person would entitle its holder to purchase US$39.00 worth of our ordinary shares for US$19.50.
This rights plan and the other anti-takeover provisions of our amended and restated memorandum and articles of
association could have the effect of depriving our shareholders of an opportunity to sell their shares at a premium over prevailing
market prices by discouraging third parties from seeking to obtain control of our company in a tender offer or similar transaction. Our
existing authorized ordinary shares confer on the holders of our ordinary shares equal rights, privileges and restrictions. The
shareholders have, by virtue of adoption of our amended and restated memorandum and articles of association, authorized the
issuance of shares of par value of US$0.01 each without specifying any special rights, privileges and restrictions. Therefore, our
board of directors may, without further action by our shareholders, issue ordinary shares, or issue shares of such class and attach to
such shares special rights, privileges or restrictions, which may be different from those associated with our ordinary shares. Preferred
shares could also be issued quickly with terms calculated to delay or prevent a change in control of our company or make removal of
management more difficult. If our board of directors decides to issue ordinary shares or preferred shares, the price of our ADSs may
fall and the voting and other rights of the holders of our ordinary shares and ADSs may be materially and adversely affected.
We have limited business insurance coverage in China.
The insurance industry in China is still at an early stage of development. Insurance companies in China offer limited
business insurance products. As a result, we do not have any business liability or disruption insurance coverage for our operations in
China. Any business disruption, litigation or natural disaster might result in our incurring substantial costs and the diversion of our
resources.
22
Some of our subsidiaries, affiliated entities and joint ventures in China engaged in certain business activities beyond the
authorized scope of their respective licenses, and if they are subject to administrative penalties or fines, our operating results may
be adversely affected.
Some of our subsidiaries, affiliated entities and joint ventures in China engaged in business activities that were not within
the authorized scope of their respective licenses in the past. The relevant PRC authorities may impose administrative fines or other
penalties for the non-compliance with the authorized scope of the business licenses, which may in turn adversely affect our operating
results.
Failure to achieve and maintain effective internal controls could have a material adverse effect on our business, results of
operations and the trading price of our ADSs.
We are subject to reporting obligations under the U.S. securities laws. The Securities and Exchange Commission, or the
SEC, as required by Section 404 of the Sarbanes-Oxley Act of 2002, has adopted rules requiring public companies to include a report
of management in its annual report that contains management’s assessment of the effectiveness of such company’s internal controls
over financial reporting.
Our management has concluded that our internal controls over financial reporting were effective as of December 31, 2015.
We however were not subject to the requirement to provide an attestation report on our management’s assessment of our internal
control over financial reporting as we were not an accelerated filer or a large accelerated filer (as defined in § 240.12b-2 under the
Securities Exchange Act of 1934, as amended, or the Exchange Act) as of December 31, 2015.
However, if we fail to maintain effective internal controls over financial reporting in the future, our management and, if
applicable, our independent registered public accounting firm may not be able to conclude that we have effective internal controls
over financial reporting at a reasonable assurance level. This could result in a loss of investor confidence in the reliability of our
financial conditions which in turn could negatively impact the trading price of our ADSs and result in lawsuits being filed against us
by our shareholders or otherwise harm our reputation. Furthermore, we have incurred and anticipate that we will continue to incur
considerable costs and use significant management time and other resources in an effort to comply with Section 404 and other
requirements of the Sarbanes-Oxley Act.
The audit report included in this annual report is prepared by auditors who are not inspected by the Public Company Accounting
Oversight Board and, as such, you are deprived of the benefits of such inspection.
Our independent registered public accounting firm that issues the audit reports included in our annual reports filed with the
SEC, as auditors of companies that are traded publicly in the United States and as a firm registered with the Public Company
Accounting Oversight Board (United States), or the PCAOB, is required by the laws of the United States to undergo regular
inspections by the PCAOB to assess its compliance with the laws of the United States and professional standards. Because our
auditors are located in the PRC, a jurisdiction where the PCAOB is currently unable to conduct inspections without the approval of
the PRC authorities, our auditors are not currently inspected by the PCAOB.
Inspections of other firms that the PCAOB has conducted outside China have identified deficiencies in those firms’ audit
procedures and quality control procedures, which may be addressed as part of the inspection process to improve future audit quality.
This lack of PCAOB inspections in China prevents the PCAOB from regularly evaluating our auditor’s audits and its quality control
procedures. As a result, investors may be deprived of the benefits of PCAOB inspections.
The inability of the PCAOB to conduct inspections of auditors in China makes it more difficult to evaluate the
effectiveness of our auditor’s audit procedures or quality control procedures as compared to auditors outside of China that are subject
to PCAOB inspections. Investors may lose confidence in our reported financial information and procedures and the quality of our
financial statements.
23
If additional remedial measures are imposed on the Big Four PRC-based accounting firms, including our independent registered
public accounting firm, in administrative proceedings brought by the SEC alleging the firms’ failure to meet specific criteria set
by the SEC, with respect to requests for the production of documents, we could be unable to timely file future financial statements
in compliance with the requirements of the Securities Exchange Act of 1934.
Starting in 2011, the Chinese affiliates of the “big four” accounting firms, including our independent registered public
accounting firm, were affected by a conflict between U.S. and Chinese law. Specifically, for certain U.S. listed companies operating
and audited in China, the SEC and the PCAOB sought to obtain from the Chinese firms access to their audit work papers and related
documents. The firms were, however, advised and directed that under China law they could not respond directly to the U.S. regulators
on those requests, and such requests by foreign regulators for access to such papers in China had to be channeled through the China
Securities Regulatory Commission, or CSRC.
In late 2012, this impasse led the SEC to commence administrative proceedings under Rule 102(e) of its Rules of Practice
and also under the Sarbanes-Oxley Act of 2002 against the Chinese accounting firms, including our independent registered public
accounting firm. A first instance trial of the proceedings in July 2013 in the SEC’s internal administrative court resulted in an adverse
judgment against the firms. The administrative law judge proposed penalties on the firms including a temporary suspension of their
right to practice before the SEC, although that proposed penalty did not take effect pending review by the commissioners of the SEC.
On February 6, 2015, before a review by the commissioner had taken place, the firms reached a settlement with the SEC. Under the
settlement, the SEC accepts that future requests by the SEC for the production of documents will normally be made to the CSRC. The
firms will receive requests matching Section 106, and are required to abide by a detailed set of procedures with respect to such
requests, which in substance require them to facilitate production via the CSRC. If they fail to meet specified criteria, the SEC retains
the authority to impose a variety of additional remedial measures on the firms depending on the nature of the failure. Remedies for
any future noncompliance could include, as appropriate, an automatic six-month bar on a single firm’s performance of certain audit
work, commencement of a new proceeding against a firm, or in extreme cases the resumption of the current proceeding against all
four firms.
In the event that the SEC restarts the administrative proceedings, depending upon the final outcome, listed companies in
the United States with major PRC operations may find it difficult or impossible to retain auditors in respect of their operations in the
PRC, which could result in financial statements being determined to not be in compliance with the requirements of the Exchange Act,
including possible delisting. Moreover, any negative news about any such future proceedings against these audit firms may cause
investor uncertainty regarding China-based, United States-listed companies and the market price of our ADSs may be adversely
affected.
If our independent registered public accounting firm were denied, even temporarily, the ability to practice before the SEC
and we were unable to timely find another registered public accounting firm to audit and issue an opinion on our financial statements,
our financial statements could be determined not to be in compliance with the requirements of the Exchange Act. Such a
determination could ultimately lead to the delisting of our ordinary shares from Nasdaq or deregistration from the SEC, or both,
which would substantially reduce or effectively terminate the trading of our ADSs in the United States.
We face risks related to health epidemics and other natural disasters.
Our business could be adversely affected by swine or avian influenza, severe acute respiratory syndrome, or SARS, or
another epidemic or outbreak. Any prolonged recurrence of swine or avian influenza, SARS or other adverse public health
developments in China may have a material adverse effect on our business operations. Our operations may be impacted by a number
of health-related factors, including, among other things, quarantines or closures of our offices which could severely disrupt our
operations, the sickness or death of our key officers and employees and closure of Internet cafés and other public areas where people
access the Internet. Any of the foregoing events or other unforeseen consequences of public health problems could adversely affect
our business and results of operations. We have not adopted any written preventive measures or contingency plans to combat any
future outbreak of swine or avian influenza, SARS or any other epidemic. In addition, other major natural disasters may also
adversely affect our business by, for example, causing disruptions of the Internet network or otherwise affecting access to our games,
or resulting in damages to our facilities.
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Risks Related to Doing Business in China
Our business may be adversely affected by public opinion and government policies in China.
Currently, most of our recurring users are young males, including students. Due to the higher degree of user loyalty to
MMORPGs, easy access to personal computers and Internet cafés, and lack of more appealing forms of entertainment in China, many
teenagers frequently play online games. This may result in these teenagers spending less time on, or refraining from, other activities,
including education and sports. Internet cafés, which are currently the most important outlets for online games, have been criticized
by the general public in China as exerting a negative influence on young people. Due primarily to such adverse public reaction, some
local governments in China have tightened their regulation of Internet café operations through, among other things, limiting the
number of new operating licenses issued and further reducing the hours during which Internet cafés are permitted to be open for
business. Also, local and higher-level governmental authorities may from time to time decide to more strictly enforce the customers’
age limit and other requirements relating to Internet cafés as a result of the occurrence of, and the media attention on, gang fights,
arson or other incidents in or related to Internet cafés. As a significant portion of our customers’ access our games from Internet cafés,
any restrictions placed on Internet café operations could result in a reduction of the amount of time our customers spend on our online
games or a reduction or slowdown in the growth of our customer base, thus adversely affecting our business and results of operations.
In April 2007, various governmental authorities, including GAPP, MIIT, the Ministry of Education, the Ministry of Public
Security, and other relevant authorities jointly issued a circular concerning the mandatory implementation of an “anti-fatigue system”
in online games, which aims to protect the physical and psychological health of minors. This circular required all online games to
incorporate an “anti-fatigue system” and an identity verification system, both of which have limited the amount of time that a minor
or other user may continuously spend playing an online game. We have implemented such “anti-fatigue” and identification systems
on all of our online games as required. Since March 2011, various governmental authorities, including MIIT, the Ministry of
Education, the Ministry of Public Security, and other relevant authorities have jointly launched the “Online Game Parents
Guardianship Project for Minors,” which allows parents to require online game operators to take relevant measures to limit the time
spent by the minors playing online games and the minors’ access to their online game accounts. On February 5, 2013, the Ministry of
Culture, MIIT, GAPP and various other governmental authorities, jointly issued the Working Plan on the Comprehensive Prevention
Scheme on Online Game Addiction of Minors, which further strengthens the administration of Internet cafés, reinstates the
importance of the “anti-fatigue system” and “Online Game Parents Guardianship Project for Minors” as prevention measures against
the online game addiction of minors and orders all relevant governmental authorities to take all necessary actions in implementing
such measures. Further strengthening of these systems, or enactment by the PRC government of any additional laws to further tighten
its administration over the Internet and online games or its supervision of Internet cafés may result in less time spent by customers or
fewer customers playing our online games, which may materially and adversely affect our business results and prospects for future
growth.
Adverse changes in economic and political policies of the PRC government could have a material adverse effect on the overall
economic growth of China, which could adversely affect our business.
We conduct substantially all of our business operations in China. As the gaming industry is highly sensitive to business
and personal discretionary spending, it tends to decline during general economic downturns. Accordingly, our results of operations,
financial condition and prospects are subject to a significant degree to economic, political and legal developments in China. China’s
economy differs from the economies of most developed countries in many respects, including with respect to the amount of
government involvement, level of development, growth rate, control of foreign exchange and allocation of resources. While the PRC
economy has experienced significant growth in the past twenty years, growth has slowed down since 2012 and has been uneven
across different regions and among various economic sectors of China. The PRC government has implemented various measures to
encourage economic development and guide the allocation of resources. While some of these measures benefit the overall PRC
economy, they may also have a negative effect on us. For example, our financial condition and results of operations may be adversely
affected by government control over capital investments or changes in tax regulations that are applicable to us. As the PRC economy
is increasingly intricately linked to the global economy, it is affected in various respects by downturns and recessions of major
economies around the world. The various economic and policy measures the PRC government enacts to forestall economic downturns
or shore up the PRC economy could affect our business.
25
Although the PRC government has implemented measures emphasizing the utilization of market forces for economic
reform, the reduction of state ownership of productive assets and the establishment of improved corporate governance in business
enterprises, a substantial portion of productive assets in China are still owned by the PRC government. In addition, the PRC
government continues to play a significant role in regulating industry development by imposing industrial policies. The PRC
government also exercises significant control over China’s economic growth through the allocation of resources, controlling payment
of foreign currency-denominated obligations, setting monetary policy and providing preferential treatment to particular industries or
companies. These actions, as well as future actions and policies of the PRC government, could materially affect our liquidity and
access to capital and our ability to operate our business.
The laws and regulations governing the online game industry in China are developing and subject to future changes. If we fail to
obtain or maintain all applicable permits and approvals, our business and operations could be materially and adversely affected.
The online game industry in China is highly regulated by the PRC government. Various regulatory authorities of the PRC
central government, such as the State Council, MIIT, GAPPRFT, the Ministry of Culture and the Ministry of Public Security, are
empowered to issue and implement regulations governing various aspects of the online games industry.
We are required to obtain applicable permits or approvals from different regulatory authorities in order to provide online
games to our customers. For example, an Internet content provider must obtain a value-added telecommunications business operating
license for ICP, or ICP License, in order to engage in any commercial ICP operations within China. In addition, an online games
operator must also obtain a license from the Ministry of Culture and a license from GAPPRFT in order to distribute games through
the Internet. Furthermore, an online game operator is required to obtain approval from the Ministry of Culture in order to distribute
virtual currencies for online games such as prepaid value cards, prepaid money or game points. If we fail to obtain or maintain any of
the required filings, permits or approvals in the future, we may be subject to various penalties, including fines and the discontinuation
or restriction of our operations. Any such disruption in our business operations would materially and adversely affect our financial
condition and results of operations.
As the online games industry is at an early stage of development in China, new laws and regulations may be adopted from
time to time to require additional licenses and permits other than those we currently have, and may address new issues that arise from
time to time. As a result, substantial uncertainties exist regarding the interpretation and implementation of current and any future PRC
laws and regulations applicable to the online gaming industry. We cannot assure you that we will be able to timely obtain any new
license required in the future, or at all. While we believe that we are in compliance in all material respects with all applicable PRC
laws and regulations currently in effect, we cannot assure you that we will not be found in violation of any current or future PRC laws
and regulations.
Intensified government regulation of Internet cafés could limit our ability to maintain or increase our revenues and expand our
customer base.
In April 2001, the PRC government began tightening its supervision of Internet cafés, closing down unlicensed Internet
cafés, and required those remaining open to install software to prevent access to sites deemed subversive and required web portals to
sign a pledge not to host subversive sites. Furthermore, the PRC government’s policy, which encourages the development of a limited
number of national and regional Internet café chains and discourages the establishment of independent Internet cafés, may slow the
overall growth of Internet cafés. Currently, the issuance of Internet café licenses is subject to the overall planning of the Ministry of
Culture and the local branches of the Ministry of Culture above certain level in respect of the total number and location of Internet
cafés. Since 2004, the grant of new Internet café licenses has been suspended from time to time, and was again suspended in 2007.
The PRC government maintains strict controls on the granting of new licenses. As Internet cafés are the primary venue for users to
play our games, any reduction in the number, or any slowdown in the growth of, Internet cafés in China will limit our ability to
maintain or increase our revenues and expand our customer base, which will in turn materially and adversely affect our business and
results of operations.
26
Regulation and censorship of information disseminated over the Internet in China may adversely affect our business, and we may
be liable for information displayed on, retrieved from, or linked to our Internet websites.
The PRC government has adopted certain regulations governing Internet access and the distribution of news and other
information over the Internet. Under these regulations, Internet content providers and Internet publishers are prohibited from posting
or displaying over the Internet content that, among other things, violates PRC laws and regulations, impairs the national dignity of
China, or is obscene, superstitious, fraudulent or defamatory. Failure to comply with these requirements could result in the revocation
of ICP and other required licenses and the closure of the concerned websites. The website operator may also be held liable for such
prohibited information displayed on, retrieved from or linked to such website.
The Ministry of Culture has promulgated laws and regulations that reiterate the government’s policies to prohibit the
distribution of games with violence, cruelty or other elements that are believed to have the potential effect of instigating crimes, and
to prevent the influx of harmful cultural products from overseas.
The Ministry of Culture has promulgated laws and regulations that require, among other things, (i) the review and prior
approval of (i) all new online games licensed from foreign game developers and related license agreements, (ii) the review of patches
and updates with substantial changes of games which have already been approved, and (iii) the filing of domestically developed
online games. Furthermore, online games, regardless of whether imported or domestic, will be subject to content review and approval
by GAPPRFT prior to the commencement of games operations in China. Failure to obtain or renew approvals or to complete filings
for online games, including mobile games, may materially delay or otherwise affect game operator’s plans to launch new games, and
the operator may be subject to fines, restriction or suspension of operations of the related games or revocation of licenses in the event
that the relevant governmental authority believes that the violation is severe. We obtained the necessary approvals from and
completed necessary filings with the Ministry of Culture and GAPP for operations of our games as applicable. Consistent with the
general practice of the mobile and TV game industry in China, we have not yet completed filings with the Ministry of Culture and
GAPPRFT for our mobile and TV games before we commenced our operations. If any such negative event occurs, our business,
financial condition and results of operations may be materially and adversely affected.
In addition, MIIT has published regulations that subject website operators to potential liability for content included on their
websites and the actions of users and others using their websites, including liability for violations of PRC laws prohibiting the
dissemination of content deemed to be socially destabilizing. The Ministry of Public Security has the authority to order any local
Internet service provider to block any Internet website maintained outside China at its sole discretion. Periodically, the Ministry of
Public Security has stopped the dissemination over the Internet of information which it believes to be socially destabilizing. The State
Secrecy Bureau, which is directly responsible for the protection of State secrets of the PRC government, is authorized to block any
website it deems to be leaking state secrets or failing to meet the relevant regulations relating to the protection of state secrets in the
dissemination of online information.
As these regulations are subject to interpretation by the relevant authorities, it may not be possible for us to determine in all
cases the type of content that could result in liability for us as a website operator. In addition, we may not be able to control or restrict
the content of other Internet content providers linked to or accessible through our websites, or content generated or placed on our
websites by our users, despite our attempt to monitor such content. To the extent that regulatory authorities find any portion of our
content objectionable, they may require us to limit or eliminate the dissemination of such information or otherwise curtail the nature
of such content on our websites, which may reduce our user traffic and have a material adverse effect on our financial condition and
results of operations. In addition, we may be subject to significant penalties for violations of those regulations arising from
information displayed on, retrieved from or linked to our websites, including a suspension or shutdown of our operations.
27
Future movements in exchange rates between the U.S. dollar and the RMB may adversely affect the value of our ADSs.
We are exposed to foreign exchange risk arising from various currency exposures. Our profit or loss in Red 5, a portion of
our financial assets, and the Convertible Notes are denominated in U.S. dollars while currently a significant portion of our revenues
are denominated in RMB, the legal currency in China. We have not used any forward contracts or currency borrowings to hedge our
exposure to foreign currency risk. The value of the RMB against the U.S. dollar and other currencies may fluctuate and is affected by,
among other things, changes in political and economic conditions and China’s foreign exchange policies. On July 21, 2005, the PRC
government changed its decade-old policy of pegging the value of the RMB to the U.S. dollar. Under the new policy, the RMB is
permitted to fluctuate within a managed band based on market supply and demand and by reference to a basket of certain foreign
currencies. Since the change in policy in July 2005, the RMB appreciated more than 20% against the U.S. dollar over the following
three years. Between July 2008 and June 2010, this appreciation halted and the exchange rate between the RMB and the U.S. dollar
remained within a narrow band. Since June 2010, the RMB has fluctuated against the U.S. dollar, at times significantly and
unpredictably. It is difficult to predict how market forces or PRC or U.S. government policy may impact the exchange rate between
the RMB and the U.S. dollar in the future.
A significant portion of our revenues and costs are denominated in RMB, while a portion of our financial assets are
denominated in U.S. dollars. We rely substantially on dividends and other fees paid to us by our subsidiaries and affiliated entities in
China. Any significant appreciation of RMB against the U.S. dollar may adversely affect our cash flows, revenues, earnings and
financial position, and the value of, and any dividends payable on, our ADSs in U.S. dollars. For example, an appreciation of the
RMB against the U.S. dollar would make any new RMB denominated investments or expenditures more costly to us, to the extent
that we need to convert U.S. dollars into RMB for such purposes. An appreciation of RMB against the U.S. dollar would also result in
foreign currency translation losses for financial reporting purposes when we translate our U.S. dollar denominated financial assets
into RMB, as RMB is our reporting currency. Conversely, a significant depreciation of the RMB against the U.S. dollar may
significantly reduce the U.S. dollar equivalent of our earnings, which in turn could adversely affect the price of our ADSs.
Restrictions on currency exchange in China limit our ability to utilize our revenues effectively, make dividend payments and meet
our foreign currency denominated obligations.
Currently, a significant portion of our revenues are denominated in RMB. Restrictions on currency exchange in China limit
our ability to utilize revenues generated in RMB to fund our business activities outside China, make dividend payments in U.S.
dollars, or obtain and remit sufficient foreign currency to satisfy our foreign currency-denominated obligations, such as paying
license fees and royalty payments. The principal regulation governing foreign currency exchange in China is the Foreign Exchange
Administration Rules (1996), as amended. Under such rules, the RMB is generally freely convertible for trade and service-related
foreign exchange transactions, but not for direct investment, loans or investment in securities outside China unless the prior approval
of SAFE is obtained. Although the PRC government regulations now allow greater convertibility of RMB for current account
transactions, significant restrictions still remain. For example, foreign exchange transactions under our PRC subsidiaries’ capital
account, including principal payments in respect of foreign currency-denominated obligations, remain subject to significant foreign
exchange controls and the approval of SAFE. These limitations could affect our ability to obtain foreign exchange for capital
expenditures. We cannot be certain that the PRC regulatory authorities will not impose more stringent restrictions on the
convertibility of the RMB, especially with respect to foreign exchange transactions.
PRC regulations relating to the establishment of offshore special purpose companies by PRC residents may subject our PRC
resident shareholders or us to penalties and fines, and limit our ability to inject capital into our PRC subsidiaries, limit our
subsidiaries’ ability to increase their registered capital, distribute profits to us, or otherwise adversely affect us.
On July 4, 2014, SAFE issued the Circular on Several Issues Concerning Foreign Exchange Administration of Domestic
Residents Engaging in Overseas Investment, Financing and Round-Trip Investment via Special Purpose Vehicles, or SAFE Circular
37. SAFE Circular 37 and its detailed guidelines require PRC residents to register with the local branch of SAFE before contributing
their legally owned onshore or offshore assets or equity interest into any special purpose vehicle, or SPV, directly established, or
indirectly controlled, by them for the purpose of investment or financing. SAFE Circular 37 further requires that when there is (a) any
change to the basic information of the SPV, such as any change relating to its individual PRC resident shareholders, name or
operation period or (b) any material change, such as increase or decrease in the share capital held by its individual PRC resident
shareholders, a share transfer or exchange of the shares in the SPV, or a merger or split of the SPV, the PRC resident must register
such changes with the local branch of SAFE on a timely basis.
28
We have requested all of our shareholders who, based on our knowledge, are PRC residents or whose ultimate beneficial
owners are PRC residents to comply with all applicable SAFE registration requirements. However, we have no control over our
shareholders. We cannot assure you that the PRC beneficial owners of our company and our subsidiaries have completed the required
SAFE registrations or complied with other related requirements. Nor can we assure you that they will be in full compliance with the
SAFE registration in the future. Any non-compliance by the PRC beneficial owners of our company and our subsidiaries may subject
us or such PRC resident shareholders to fines and other penalties. It may also limit our ability to contribute additional capital to our
PRC subsidiaries and our subsidiaries’ ability to distribute profits or make other payments to us.
Uncertainties with respect to the PRC legal system could adversely affect us.
We conduct our business primarily through our subsidiaries and affiliated entities incorporated in China. These entities are
generally subject to laws and regulations applicable to foreign investment in China and, in particular, laws applicable to wholly-
foreign owned enterprises. Almost all of these agreements are governed by PRC law and disputes arising out of these agreements are
expected to be decided by arbitration in China. The PRC legal system is based on written statutes. Prior court decisions may be cited
for reference but have limited precedential value. PRC legislation and regulations have significantly enhanced the protections
afforded to various forms of foreign investments in China for the past decades. However, since the PRC legal system continues to
rapidly evolve, the interpretations of many laws, regulations and rules are not always uniform and enforcement of these laws,
regulations and rules involves uncertainties, which may limit legal protections available to us. In addition, any litigation in China may
be protracted and result in substantial costs and diversion of resources and management attention.
Substantial uncertainties exist with respect to the enactment timetable, interpretation and implementation of the draft PRC
Foreign Investment Law and how it may impact the viability of our current corporate structure, corporate governance and
business operations.
In January 2015, MOFCOM published a draft of the proposed Foreign Investment Law, or Draft FIL. If enacted, the Draft
FIL would replace the existing laws regulating foreign investment in China and harmonize the regulations governing both foreign
invested enterprises and PRC domestic entities. However, foreign invested enterprises that operate in industries deemed to be either
“restricted” or “prohibited” in a “negative list” will be subject to entry clearance and other approvals not required for PRC domestic
entities unless such foreign invested enterprises can demonstrate that the ultimate controlling person(s) is/are of PRC nationality
(either PRC citizen, or PRC government and its branches or agencies). Because the negative list has yet to be published, it is unclear
whether it will differ from the current list of industries subject to restrictions or prohibitions on foreign investment. The entry
clearance and approvals could prevent certain foreign invested enterprises that operate in industries on the negative list from
continuing to conduct their operations through contractual arrangements.
There is substantial uncertainty regarding the Draft FIL, including, the content of its final form and the timing of its
adoption and implementation. For example, our actual controlling person, Mr. Jun Zhu, is a citizen of Singapore, which could be one
of the significant factors for purposes of determining whether we are ultimately controlled by persons that are of PRC nationality
under the Draft FIL. Moreover, it is uncertain whether the Internet content provision service, online gaming, internet publishing and
other internet-based industries, in which our subsidiaries and affiliated entities operate, will be subject to the foreign investment
restrictions or prohibitions set forth in the “negative list” to be issued. If adopted in its current form, the Draft FIL could have a
material and adverse impact on our ability to participate in key sectors of the Chinese economy, including the online game business,
as well as the effectiveness or the necessity of our contractual arrangements with our affiliated entities.
29
We may not be able to pursue growth through strategic acquisitions in China due to complicated procedures under PRC laws and
regulations for foreign investors to acquire PRC companies.
In recent years, certain PRC laws and regulations have established procedures and requirements that are expected to make
merger and acquisition activities in China by foreign investors more time-consuming and complex. These laws and regulations
include, without limitation, the Rules on the Merger and Acquisition of Domestic Enterprises by Foreign Investors, or the M&A
Rules, and the Anti-Monopoly Law and the MOFCOM Security Review Rules. In some instances, MOFCOM needs to be notified in
advance of any change-of-control transaction in which a foreign investor takes control of a PRC domestic enterprise. The approval by
MOFCOM may also need to be obtained in circumstances where overseas companies established or controlled by PRC enterprises or
residents acquire affiliated domestic companies. PRC laws and regulations also require certain merger and acquisition transactions to
be subject to merger control review or security review. The MOFCOM Security Review Rules, effective from September 1, 2011,
provide that, when deciding whether a specific merger or acquisition of a domestic enterprise by foreign investors shall be subject to
the security review by MOFCOM, the principle of substance over form shall be applied. In particular, foreign investors are prohibited
from bypassing the security review requirement by structuring transactions through proxies, trusts, indirect investments, leases, loans,
control through contractual arrangements or offshore transactions.
If the business of any target company that we expect to acquire becomes subject to the security review, we may not be able
to successfully complete the acquisition of such company, either by equity or asset acquisition, capital contribution or through any
contractual arrangement. Complying with the requirements of the PRC laws and regulations to complete acquisition transactions
could become more time-consuming and complex. Any required approval, such as approval by MOFCOM, may delay or inhibit our
ability to complete such transactions, which could affect our ability to grow our business or increase our market share. Furthermore, it
is uncertain whether the M&A Rules, security review rules or the other PRC regulations regarding the acquisitions of PRC companies
by foreign investors will be amended when the Draft FIL becomes effective in the future.
The limited use of personal computers in China and the relatively high cost of Internet access with respect to per capita gross
domestic product may limit the development of the Internet in China and impede our growth.
Although the use of personal computers in China has increased in recent years, the penetration rate for personal computers
in China is significantly lower than in the United States and other developed countries. Furthermore, despite a decrease in the cost of
Internet access in China due to a decrease in the cost of personal computers and the introduction and expansion of broadband access,
the cost of Internet access in China still remains relatively high compared to the average per capita income. The limited use of
personal computers in China and the relatively high cost of Internet access may limit the growth of our business. In addition, there is
no assurance that there will not be any increase in Internet access or telecommunication fees in China. If that happens, the number of
our users may decrease and the growth of our user base may be materially impeded.
The continued growth of China’s Internet market depends on the establishment of adequate telecommunications infrastructure.
Although private sector Internet service providers currently exist in China, almost all access to the Internet is maintained
through state-owned telecommunication operators under the administrative control and regulatory supervision of China’s MIIT. In
addition, the national networks in China connect to the Internet through government-controlled international gateways. These
government-controlled international gateways are the only channel through which a domestic PRC user can connect to the
international Internet network. We rely on this infrastructure to provide data communications capacity primarily through local
telecommunications lines. Although the government has announced plans to aggressively develop the national information
infrastructure, we cannot assure you that this infrastructure will be developed as planned or at all. In addition, we will have no access
to alternative networks and services, on a timely basis if at all, in the event of any infrastructure disruption or failure. The Internet
infrastructure in China may not support the demands necessary for the continued growth in Internet usage.
30
Risks Related to Our Shares and ADSs
Our ADSs may be delisted from the Nasdaq Global Market as a result of our not meeting the Nasdaq Global Market continued
listing requirements.
Our ADSs are currently listed on the Nasdaq Global Market under the symbol “NCTY.” We must continue to meet the
requirements set forth in Nasdaq Listing Rule 5450 to remain listing on the Nasdaq Global Market. The listing standards of the
NASDAQ Global Market provide that a company, in order to qualify for continued listing, must maintain a minimum ADS price of
US$1.00 and satisfy standards relative to minimum shareholders’ equity, minimum market value of publicly held shares and various
additional requirements. If we fail to satisfy Nasdaq Global Market’s continued listing requirements in the future and fail to regain
compliance on a timely basis, our ADSs could be delisted from Nasdaq Global Market, and we may need to transfer the listing or
trading of our ADSs to other stock exchange or trading venues.
However, there can be no assurance that our ADSs will be eligible for trading on any such alternative exchanges or
markets in the United States. If Nasdaq determines to delist our ordinary shares, or if we fail to list our ADSs on other stock
exchanges or find alternative trading venue for our ADSs, the market liquidity and the price of our ADSs and our ability to obtain
financing for our operations could be materially and adversely affected.
We may be classified as a passive foreign investment company for the taxable year ended December 31, 2015, which could result
in adverse U.S. federal income tax consequences to U.S. Holders of our ADSs or ordinary shares.
Based on the market price of our ADSs and the value and composition of our assets and liabilities, we believe we were not
a “passive foreign investment company” (“PFIC”), for U.S. federal income tax purposes for our taxable year ended December 31,
2015. However, as previously disclosed, although not free from doubt, we believed that we were a PFIC for U.S. federal income tax
purposes for prior years. In addition, it is possible that one or more of our subsidiaries were also PFICs for such year for U.S. federal
income tax purposes.
A non-U.S. corporation will be a PFIC for any taxable year if either (1) at least 75% of its gross income for such year
consists of certain types of passive income, or (2) at least 50% of the average quarterly value of its assets (as generally determined on
the basis of fair market value) during such year produce or are held for the production of passive income. We must make a separate
determination after the close of each taxable year as to whether we were a PFIC for that year. Because the value of our assets for
purposes of the PFIC test will generally be determined by reference to the market price of our ADSs or ordinary shares, our PFIC
status will depend in part on the market price of the ADSs or ordinary shares, which may fluctuate significantly, and the composition
of our assets and liabilities.
If we were treated as a PFIC for any taxable year during which a U.S. Holder (as defined in Item 10. Additional
Information—E. Taxation—U.S. Federal Income Taxation) holds our ADSs or ordinary shares, such U.S. Holders may incur
significantly increased U.S. income tax on gain recognized on the sale or other disposition of the ADSs or ordinary shares and on the
receipt of distributions on the ADSs or ordinary shares to the extent such gain or distribution is treated as “excess distribution” under
the U.S. federal income tax rules. Further, a U.S. Holder will generally be treated as holding an equity interest in a PFIC in the first
taxable year of the U.S. Holder’s holding period in which we become classified as a PFIC and subsequent taxable years (“PFIC-
Tainted Shares”) even if, we in fact, cease to be a PFIC in subsequent taxable years. See “Item 10. Additional Information—E.
Taxation—U. S. Federal Income Taxation—Passive Foreign Investment Company.”
You are strongly urged to consult your tax advisors regarding the impact of our being a PFIC in any taxable year on your
investment in our ADSs and ordinary shares as well as the application of the PFIC rules.
31
Substantial future sales or the perception of sales of our ADSs or ordinary shares could adversely affect the price of our ADSs.
If our shareholders sell or are perceived by the market to sell substantial amounts of our ADSs, including those issued upon
the exercise of outstanding options, in the public market, the market price of our ADSs could fall. Such sales also might make it more
difficult for us to sell equity or equity-related securities in the future at a time and price that we deem appropriate. If any existing
shareholder or shareholders sell or are perceived by the market to sell a substantial amount of ordinary shares, the prevailing market
price for our ADSs could be adversely affected. In December 2015, we issued and sold the Convertible Notes in an aggregate
principal amount of US$40,050,000 to Spendid Days in three tranches at initial conversion prices of US$2.6, US$5.2 and US$7.8 per
ADS, respectively. In connection with the sale of Convertible Notes, we also issued the Warrants in an aggregate principal amount of
US$9,950,000 to Splendid Days in four tranches at initial exercise prices of US$1.5, US$2.6, US$5.2 and US$7.8 per ADS,
respectively. See “Item 5—Operating and Financial Review and Prospects—B. Liquidity and Capital Resources—Cash Flows and
Working Capital.” We will register the ordinary shares into which the Convertible Notes are convertible and the Warrants are
exercisable on a registration statement on F-3, and use our best efforts to cause such registration statement to be declared effective by
the SEC as promptly as possible after the initial filing. Upon registration, any ordinary shares that Splendid Days would acquire by
conversion of the Convertible Notes or exercise of the Warrants will become freely tradable.
In addition, we may issue additional ordinary shares or ADSs for future acquisitions. If we pay for our future acquisitions
in whole or in part with additionally issued ordinary shares or ADSs, your ownership interest in our company would be diluted and
this, in turn, could have a material adverse effect on the price of our ADSs.
The market price for our ADSs may be volatile.
The market price for our ADSs is likely to be highly volatile and subject to wide fluctuations in response to factors
including the following:
•
•
•
•
•
•
•
•
•
•
actual or anticipated fluctuations in our operating results;
announcements of new games by us or our competitors;
changes in financial estimates by securities analysts;
price fluctuations of publicly traded securities of other China-based companies engaging in Internet-related services
or other similar businesses;
conditions in the Internet or online game industries;
changes in the economic performance or market valuations of other Internet or online game companies;
announcements by us or our competitors of significant acquisitions, strategic partnerships, joint ventures or capital
commitments;
fluctuations in the exchange rates between the U.S. dollar and the RMB;
addition or departure of key personnel; and
pending and potential litigation.
In addition, the securities market has from time to time experienced significant price and volume fluctuations that are not
related to the operating performance of particular companies. These market fluctuations may also materially and adversely affect the
market price of our ADSs.
32
You may face difficulties in protecting your interests, and our ability to protect our rights through the U.S. federal courts may be
limited, because we are incorporated under Cayman Islands law.
Our corporate affairs are governed by our memorandum and articles of association and by the Companies Law (2013
Revision) and common law of the Cayman Islands. The rights of our shareholders and the fiduciary duties of our directors under
Cayman Islands law are not as clearly established as they would be under statutes or judicial precedents in the United States. In
particular, the Cayman Islands has a less developed body of securities laws as compared to the United States, and provides
significantly less protection to investors. Therefore, our public shareholders may have more difficulties protecting their interests in
the face of actions by our management, directors or controlling shareholders than would shareholders of a corporation incorporated in
a jurisdiction in the United States. In addition, shareholders of Cayman Islands companies may not have standing to initiate a
shareholder derivative action before the federal courts of the United States. As a result, our shareholders may not be able to protect
their interests if they are harmed in a manner that would otherwise enable them to sue in a United States federal court.
Your ability to bring an action against us or against our directors and officers, or to enforce a judgment against us or them, will
be limited because we are incorporated in the Cayman Islands, because we conduct a substantial portion of our operations in
China and because the majority of our directors and officers reside outside of the United States.
We are an exempted company incorporated in the Cayman Islands, and we conduct a substantial portion of our operations
through our wholly-owned subsidiaries and affiliated entities in China. Most of our directors and officers reside outside of the United
States and most of the assets of those persons are located outside of the United States. As a result, it may be difficult or impossible for
you to bring an action against us or against these individuals in the United States in the event that you believe that your rights have
been infringed under the securities laws or otherwise. Even if you are successful in bringing an action of this kind, the laws of the
Cayman Islands and of China may render you unable to enforce a judgment against our assets or the assets of our directors and
officers.
You may not be able to exercise your right to vote.
As a holder of ADSs, you may instruct the depositary of our ADSs to vote the shares underlying your ADSs but only if we
ask the depositary to request your instruction. Otherwise, you will not be able to exercise your right to vote unless you withdraw the
shares. However, you may not know about a shareholders’ meeting enough in advance to withdraw the shares. Pursuant to our
amended and restated memorandum and articles of association, a shareholders’ meeting may be convened by us on seven business
days’ notice. If we ask for your instructions, the depositary will notify you of the upcoming vote and arrange to deliver our voting
materials to you. We cannot assure you that you will receive the voting materials in time to ensure that you can instruct the depositary
to vote your shares. Pursuant to the amended and restated Deposit Agreement dated November 2010 that we entered into with our
depositary, if after complying with the procedures set forth in the agreement, the depositary does not receive instructions from the
owner of a receipt on or before the instruction date, the depositary shall vote such deposited securities in accordance with the
recommendations of our board of directors as advised by our company in writing. In addition, the depositary and its agents are not
responsible for failing to carry out voting instructions or for the manner of carrying out voting instructions, if any such action or non-
action is in good faith. This means that you may not be able to exercise your right to vote and there may be nothing you can do if the
shares underlying your ADSs are not voted as you request.
Your right to participate in any future rights offerings may be limited, which may cause dilution to your holdings.
We may from time to time distribute rights to our shareholders, including rights to acquire our securities. However, we
cannot make rights available to you in the United States unless we register the rights and the securities to which the rights relate under
the Securities Act of 1933, as amended, or the Securities Act, or an exemption from the registration requirements is available. Also,
under the deposit agreement, the depositary bank will not make rights available to you unless the distribution to ADS holders of both
the rights and any related securities are either registered under the Securities Act, or exempt from registration under the Securities
Act. We are under no obligation to file a registration statement with respect to any such rights or securities or to endeavor to cause
such a registration statement to be declared effective. Moreover, we may not be able to establish an exemption from registration under
the Securities Act. The depositary may, but is not required to, sell such undistributed rights to third parties in this situation.
Accordingly, you may be unable to participate in our rights offerings and may experience dilution in your holdings.
33
You may not receive distributions on ordinary shares or any value for them if it is illegal or impractical to make them available to
you.
The depositary of our ADSs has agreed to pay to you the cash dividends or other distributions it or the custodian receives
on ordinary shares or other deposited securities after deducting its fees and expenses. You will receive these distributions in
proportion to the number of ordinary shares your ADSs represent. However, the depositary is not responsible if it decides that it is
unlawful or impractical to make a distribution available to any holders of ADSs. We have no obligation to register ADSs, ordinary
shares, rights or other securities under U.S. securities laws. We also have no obligation to take any other action to permit the
distribution of ADSs, ordinary shares, rights or anything else to holders of ADSs. This means that you may not receive the
distribution we make on our ordinary shares or any value for them if it is illegal or impractical for us to make them available to you.
These restrictions may have a material adverse effect on the value of your ADSs.
You may be subject to limitations on transfer of your ADSs.
Your ADSs are transferable on the books of the depositary. However, the depositary may close its transfer books at any
time or from time to time when it deems expedient in connection with the performance of its duties. In addition, the depositary may
refuse to deliver, transfer or register transfers of ADSs generally when our books or the books of the depositary are closed, or at any
time if we or the depositary deem it advisable to do so because of any requirement of law or of any government or governmental
body, or under any provision of the deposit agreement, or for any other reason.
Item 4.
INFORMATION ON THE COMPANY
A. History and Development of the Company
We were incorporated in the Cayman Islands on December 22, 1999 under the name GameNow.net Limited as a company
limited by shares and were renamed The9 Limited in February 2004. We formed GameNow.net (Hong Kong) Limited, or GameNow,
on January 17, 2000 in Hong Kong, as a wholly-owned subsidiary. We have historically conducted our operations in large part
through The9 Computer, a direct wholly-owned subsidiary of GameNow in China.
Due to the current restrictions on foreign ownership of ICP and Internet culture operation in China, currently, we primarily
rely on Shanghai IT, one of our affiliated PRC entities, in holding certain licenses and approvals necessary for our business online
game operations through a series of contractual arrangements with Shanghai IT and its shareholders. See “Item 7. Major Shareholders
and Related Party Transactions—B. Related Party Transactions—Arrangements with Affiliated PRC Entities” for details of the
contractual arrangements with Shanghai IT and its shareholders. We do not hold any equity interest in Shanghai IT.
We operated WoW, a MMORPG licensed from Blizzard Entertainment, Inc., in China between June 2005 and June 2009
and had relied on the game as a major source of revenue during that period. After the non-renewal of the WoW license, we continued
to operate our other licensed and proprietary games.
In April 2010, we acquired a controlling interest in Red 5, an online game developer based in the United States. As of
December 31, 2015, on an as-converted basis, we and Shanghai Oriental Pearl (Group) Co., Ltd., which is a public company listed on
the Shanghai Stock Exchange and operates in culture and entertainment industry in China, owned approximately 72.8% and 22.8%,
respectively, of the equity interest in Red 5. Red 5 is developing Firefall, a MMOFPS game, for which we conducted a limited
commercial release in China in November 2015 and expect to have a large-scale commercial launch in China in the second half of
2016. We have licensed Firefall to System Link, our joint venture with Qihoo 360 Technology Co., Ltd., or Qihoo 360, for publishing
and operating Firefall for a five-year term in China, as discussed below.
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In July 2014, we and Qihoo 360 entered into an agreement to form a joint venture in which each party shall own 50% equity
interest in the joint venture and share profits based on the respective equity interests in the joint venture. The joint venture, System Link
Corporation Limited, or System Link, was formed in August 2014. In August 2014, our subsidiary Red 5 Singapore Pte. Ltd., or Red 5
Singapore, entered into a license agreement with System Link for publishing and operating Firefall for a five-year term in China. Under this
license agreement, System Link is expected to pay to us no less than US$160 million (including license fee and royalties) during the term of
the agreement. We do not consolidate the results of System Link into our results of operations and treat it as an equity investee.
In February 2013, we established a new joint venture, namely Zhongxing The9 Network Technology Co., Ltd., or ZTE9, in
cooperation with Shanghai Zhongxing Communication Technology Enterprise Co., Ltd. and Shanghai Ruigao Information Technology Co.,
Ltd., in Wuxi, Jiangsu province of China, to develop and operate the business of “Fun Box,” a home entertainment set top box. In February
2014, Guangdong Hongtu Guangdian Investment Limited Company made a capital investment of RMB12.5 million to acquire 10% equity
interests in ZTE9. As of December 31, 2015, we held 30.2% equity interest of ZTE9. We do not consolidate the results of ZTE9 into our
results of operations and treat it as an equity investee.
In August 2014, Shanghai IT sold 100% equity interest in Huopu Cloud Computing Terminal Technology Co., Ltd., or Huopu
Cloud, to Shanghai Zhengwu Investment Center (Limited Partnership), a third party, for a total consideration of RMB200 million in cash.
Huopu Cloud developed and held a web game QiJiGuiLai.
In February 2016, Shanghai The9 Education Technology Co., Ltd., one of our consolidated affiliated entities, was approved to
list its shares on the National Equities Exchange and Quotations, commonly known as the New Third Board, an emerging over-the-counter
market in China. Such listing of shares remains subject to completion of registration procedures with relevant authorities in China.
In August 2015, Globe Wealthy Link Limited, or Globe Wealthy, a wholly-owned subsidiary of System Link, entered into an
agreement with Smilegate Entertainment Inc., or Smilegate, a Korean game developer, to form a joint venture. The joint venture, Oriental
Shiny Star Limited, or Oriental Shiny, was formed in August 2015. Smilegate shall hold nominal shares in Oriental Shiny upon the
incorporation of Oriental Shiny. In November 2015, Oriental Shiny entered into a license agreement with Smilegate for publishing and
operating CrossFire 2 in China on an exclusive basis for an initial term of three years, subject to an extension to five years. See “Item 4.
Information on the Company—B. Business Overview—Arrangements with Smilegate regarding CrossFire 2.” Smilegate is currently in the
process of developing CrossFire 2. We do not consolidate the results of Oriental Shiny into our results of operations and treat it as an equity
investee.
In November 2015, we disposed of 58% equity interest in Shanghai Jiucheng Advertisement Co., Ltd., or Shanghai Jiucheng
Advertisement, which operates our mobile advertising platform and was wholly-owned by Shanghai IT prior to such disposal. We account
for Shanghai Jiucheng Advertisement as an equity investment after such disposal.
In December 2015, we entered into an agreement to form a joint venture with Youku Tudou Inc., a multi-screen entertainment
and media company in China, or Youku Tudou, for the purpose of online games development and operation, movies, network television
series and network variety show production, publishing, operation and other related businesses in China. We agreed with Youku Tudou that
each party shall own 50% equity interest in the joint venture and share profits based on the respective equity interests in the joint venture.
The joint venture, Jiuhe Digital & Entertainment Co., Ltd., or Jiuhe Digital, is expected to be formed in 2016. Jiuhe Digital is expected to be
engaged in online games development and operation, movies, network television series and network variety show production, publishing,
operation and other related businesses. We do not consolidate the results of Jiuhe Digital into our results of operations and treat it as an
equity investee.
In March 2016, we entered into a non-binding memorandum of understanding, or MOU, with L&A International Holding
Limited, or L&A, a Cayman Islands company with shares publicly listed on the Growth Enterprise Market of the Hong Kong Stock
Exchange, and certain other shareholders of Red 5. Pursuant to the MOU, we have agreed to exchange approximately 30.6% equity interest
that we own in Red 5 for such number of newly issued shares of L&A which has the same value as the exchanged Red 5 equity interest. The
other participating shareholders of Red 5 will exchange an aggregate of approximately 14.4% equity interest in Red 5 based on the same
terms. The total valuation for the 45% equity interest in Red 5 subject to this exchange is expected to be approximately US$76.5 million,
subject to adjustments by no more than 15% based on the results of due diligence exercises to be conducted by both parties. The completion
of the transaction is subject to the parties’ execution of definitive agreements and customary closing conditions to be stipulated therein. If the
transaction is completed in accordance with valuation of the MOU, we expect to receive ordinary shares of L&A with a valuation ranging
from US$44 million to US$60 million.
Our principal executive office is located at Building No. 3, 690 Bibo Road, Zhangjiang Hi-Tech Park, Pudong New Area,
Shanghai 201203, People’s Republic of China, and our telephone number is +86-21-5172-9999. Our registered office in the Cayman Islands
is located at the offices of CARD Corporate Services Ltd, c/o Collas Crill Corporate Services Limited, Floor 2, Willow House, Cricket
Square, PO Box 709, Grand Cayman KY1-1107 Cayman Islands. Our agent for service of process in the United States is CT Corporation
System located at 111 Eighth Avenue, New York, New York 10011.
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B. Business Overview
We primarily operate proprietary and licensed online games, including MMOFPSs, mobile games and TV games. We have
developed proprietary games, including Firefall and Song of Knights, and are developing several proprietary mobile games. We have
also obtained an exclusive license to operate CrossFire 2, an MMOFPS in development, in China through a joint venture. We also
develop and operate the business of “Fun Box,” a home entertainment set top box, which enables online video and video games on
TV, through a joint venture.
We generate our online game service revenues primarily through an item-based revenue model, under which players play
games for free, but they are charged for in-game items, such as performance-enhancing items, clothing and accessories. Our
customers typically access our online games through personal computers, mobile devices or TVs. They purchase in-game items
primarily through our Pass9 payment system, or by using prepaid cards purchased at online game platforms. Pass9 is a proprietary,
fully integrated online membership management and payment system, which offers one-stop account management and payment
services to our customers. To ensure quality customer service and seamless operations, we maintain a powerful technology platform
consisting of numerous servers and network devices located in four Internet data centers in China.
As mobile business has become increasingly popular in China, we are also developing our mobile application platforms.
We established a mobile business unit in April 2010 and started to expand into the mobile business. We also operate our proprietary
mobile advertising platform, Juzi, and a mobile app education business.
We plan to further expand the size and capabilities of our development team by recruiting additional talented program
developers, game designers and graphic artists. We also plan to introduce new game features and improve operations infrastructure to
meet evolving customer tastes and expectations.
Products and Services
Online Games
We offer online games including MMOFPSs, mobile games and TV games that we developed or licensed. Our other
products and services include training and mobile advertising platform, which is operated by our equity investee. In a typical
MMOFPS, thousands of players play in the same game world at the same time. MMOFPS players can select a specific character to
compete within the game with which they develop experience and enhance game attributes, which can be carried over into the next
higher game levels. MMOFPSs incorporate many cutting-edge technology features, including:
•
•
•
sophisticated 3D graphics which create captivating screen scenes;
player upgrading system which allows players to attain higher game attributes with their characters as they develop
experience and enhanced game capabilities over time; and
instant messaging system which allows players to communicate with each other during the game and form groups
with other players, thereby coordinating their game skills to achieve collective objectives.
As of the date of this annual report, we or our joint ventures own or have exclusive licenses to operate the following major
online games in China and other countries:
Game
Firefall
Developer/ Licensor
Red 5
Description
3D MMOFPS
Status
Commercially launched in
North America and Europe
in July 2014;
Limited commercial release
in China in November 2015
36
Game
Developer/ Licensor
Description
Song of Knights
The9
Mobile game
CrossFire 2
Smilegate Entertainment Inc.
3D MMOFPS
Status
Expected to have a large-
scale commercial launch in
China in the second half of
2016
Limited commercial release
in China in November 2015
Under development by
Smilegate
•
Firefall. Since our acquisition of Red 5 in April 2010, Red 5 devoted substantially all of its operating activities to
the development of Firefall, a MMOFPS. Red 5 had previously entered into a game development and licensing
agreement with Webzen, a third-party operator, in February 2006.
In September 2011, pursuant to a series of assignment arrangements, Webzen assigned the license of Firefall to Red
5 Singapore. Upon the assignment, Red 5 Singapore replaced Webzen and became a party under the game
development and licensing agreement between Red 5 and Webzen, including the publishing rights in all of the
countries worldwide other than the United States, Canada and Europe, as well as all the intellectual properties
related to Firefall. Red 5 will continue to have the publishing right of Firefall in the United States, Canada and
Europe. Webzen will no longer be involved in marketing and publishing Firefall in any geographic region.
As part of the assignment arrangement, we paid US$10.0 million and guaranteed to pay US$12.7 million to
Webzen. We also pledged certain intellectual property in relation to the game to secure the guaranteed amount. As
of December 31, 2015, the outstanding guaranteed payment amount was US$3.1 million (RMB20.0 million). In
addition, Webzen will also share certain future revenues generated from the licensing and royalties of Firefall for a
certain period of time.
In November 2011, Red 5 Singapore granted a six-year license of Firefall to Garena Online Private Limited for
exclusive distribution rights in Taiwan, Singapore, Malaysia, Vietnam, Thailand, Indonesia, Hong Kong and the
Philippines, for US$23 million plus any royalties payable.
In August 2014, Red 5 Singapore entered into a license agreement with System Link, our joint venture with Qihoo
360, for System Link to publish and operate Firefall for a five-year term in China. Under this license agreement,
System Link is expected to pay to us no less than US$160 million (including license fee and royalties) during the
term of the agreement.
•
•
•
Firefall was commercially launched in North America and Europe in July 2014. We conducted a limited commercial
release on Firefall in China in November 2015 and expect to have a large-scale commercial launch of the game in
China in the second half of 2016.
Song of Knights. We have been developing our own proprietary mobile game, Song of Knights, since 2014. We
conducted a limited commercial release in China in November 2015 and expect to have a large-scale commercial
launch of the game in China in the first half of 2016. We also licensed Song of Knights to different game operators
for distribution in Korea, Vietnam, Taiwan, Malaysia, Hong Kong, Singapore and Macau.
CrossFire 2. In November 2015, our joint venture Oriental Shiny obtained an exclusive license from Smilegate to
publish and operate CrossFire 2 in China for an initial term of three years, subject to an extension to five years.
CrossFire 2 is the sequel of CrossFire, a first-person-shooter PC online game in China. Smilegate is currently in the
process of developing CrossFire 2. We do not consolidate the results of Oriental Shiny into our results of operations
and treat it as an equity investee. See “—Arrangements with Smilegate regarding CrossFire 2.”
37
In preparation for the commercial launch of a new game, we conduct “closed beta testing” of the game to resolve
operational issues, which is followed by “limited commercial release” and “open beta testing.” In both limited commercial release
and open beta testing, we allow our registered users to play without removing their in-game data to ensure the performance
consistency and stability of our operating systems. While we limit the number of users allowed to play the game in limited
commercial release, we do not set such a limit in open beta testing. We can choose to start charging users in limited commercial
release or open beta testing or at a later stage at our discretion.
Our online games are available 24 hours a day, seven days a week. Our users can access our online games from any
location with an Internet connection. Substantially all of our users in China access the game servers either from personal computers at
home or at Internet cafés equipped with multiple personal computers that have Internet access. Currently, a significant portion of our
users access the game through Internet cafés throughout China which sell prepaid game cards or prepaid game points to their
customers. To offset the impact of the limited use of online and credit card payment systems in China, we have introduced Pass9, a
prepaid game playing time purchase and management system. See “—B. Business Overview—Membership Management and
Payment System.”
TV Game Platform. In February 2013, we established ZTE9, a joint venture, with Shanghai Zhongxing Communication
Technology Enterprise Co., Ltd. and Shanghai Ruigao Information Technology Co., Ltd. in Wuxi, Jiangsu Province of China. In
February 2014, Guangdong Hongtu Guangdian Investment Limited Company made capital investment to ZTE9. The joint venture is
going to develop and operate the business of “Fun Box,” a home entertainment set top box, which enables online video and video
games on TV.
Other Products and Services
Our other products and services mainly consist of training and mobile advertising.
Training Services. Our training services primarily relate to smart phone application programming training provided to
college students in China.
Mobile Application Advertising Platform. We established a wireless business unit in April 2010 and started to expand into
the wireless business. We develop and operate our mobile advertising platform, Juzi, under our wireless business unit. Juzi is
currently operated by Shanghai Jiucheng Advertising, our equity investee.
Arrangements with Smilegate regarding CrossFire 2
In 2015, Globe Wealthy, a wholly-owned subsidiary of System Link, our 50%-owned joint venture, and Smilegate formed
Oriental Shiny as a joint venture company for publishing and operating CrossFire 2 in China on an exclusive basis for an initial term
of three years, subject to an extension to five years. Certain principal terms of the contractual arrangements are described below.
Joint Venture Agreement dated August 20, 2015 by and between Globe Wealthy and Smilegate. Pursuant to this agreement,
Globe Wealthy shall contribute to Oriental Shiny an initial capital of US$50 million, and additional capital of US$70 million and
US$180 million after closed beta testing and commercial launch of CrossFire 2, respectively. Such capital shall be used to pay the
license fee for the initial three-year term under the CrossFire 2 license agreement between Oriental Shiny and Smilegate. In addition,
Globe Wealthy will make additional cash contributions to Oriental Shiny as may be necessary for publishing, operating and
marketing CrossFire 2. If the CrossFire 2 license is extended for two years for an additional license fee of US$200 million pursuant to
the terms of the license agreement, Globe Wealthy will be required to make an additional capital contribution of US$200 million to
Oriental Shiny for the payment of such additional license fee. Smilegate shall hold nominal shares in Oriental Shiny upon the
incorporation of Oriental Shiny.
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Pursuant to the joint venture agreement, Oriental Shiny shall establish a wholly-owned subsidiary in China, which will
operate CrossFire 2 through a PRC entity that it effectively controls through a series of contractual arrangements. The wholly-owned
subsidiary, Oriental Shiny Star Information Technology (Beijing) Co., Ltd., or Oriental IT, was formed in February 2016, and the
operating PRC entity, Beijing Zhi’ao Network Technology Co., Ltd., or Beijing Zhi’ao, was formed in October 2015. Oriental IT is
expected to enter into contractual arrangements with Beijing Zhi’ao and the shareholders of Beijing Zhi’ao to obtain effective control
over Beijing Zhi’ao. The board of Oriental Shiny consists of three directors, including two directors nominated by Globe Wealthy and
one director nominated by Smilegate. Certain matters of Oriental Shiny require the unanimous consent of the directors, including,
among other things, appointment and removal of senior management, disposal of material assets, the entering into, amendment or
termination of material contracts, transfer or licensing of intellectual property or technology, declaration of dividend, and making or
extension of loans. Certain matters of Oriental Shiny require consents of both Globe Wealthy and Smilegate, including, among other
things, amendment to the articles of association, change in capital structure and merger and acquisition with other companies. The
initial term of the joint venture is 20 years, and may be terminated at any time by written agreement between Globe Wealthy and
Smilegate.
Exclusive License and Distribution Agreement dated November 24, 2015 by and among Oriental Shiny, Beijing Zhi’ao and
Smilegate. Pursuant to this agreement, Smilegate granted to Oriental Shiny and Beijing Zhi’ao an exclusive, non-sublicenseable and
non-transferable license to publish and operate CrossFire 2 in China. Oriental Shiny and Beijing Zhi’ao shall pay an initial license fee
of US$50 million, and additional license fees of US$70 million and US$180 million after closed beta testing and commercial launch
of CrossFire 2, respectively. The payment of license fee is guaranteed by Qihoo 360 and our company based on the respective equity
interests of the parties in System Link. Oriental Shiny and Beijing Zhi’ao are also required to pay Smilegate royalties. This agreement
has an initial term of three years after the commercial launch of CrossFire 2, and will be extended for two years (i) automatically if
the total gross revenue is larger than the total costs and expenses incurred by Oriental Shiny and Beijing Zhi’ao for the initial three-
year term, or (2) at the option of Oriental Shiny and Beijing Zhi’ao. In either case, any extension for a two-year term will be subject
to an additional license fee of US$200 million. This agreement may be terminated upon agreement by the parties.
Guarantee Letter dated November 24, 2015 by and among the our company, Shanghai IT and Smilegate. Our company and
Shanghai IT agreed to jointly and severally guarantee the payment of license fee by Globe Wealthy under the Exclusive License and
Distribution Agreement proportional to our equity interest in System Link. The remaining licensing fee is guaranteed by Qihoo 360
under a separate guarantee letter.
Membership Management and Payment System
We established Pass9 in China, a pioneering integrated membership management and payment system in early 2001,
which allows us to maintain a single customer database that contains each customer’s profile and payment history. Pass9 provides
one-stop service to our customers, distributors and developers. Pass9 provides our customers with an integrated platform to log in,
pay and use any of the fee-based products and services we offer. It also allows our distributors to sell our online points to Internet
cafés, and enables Internet cafés to check the balance of their points and pay us on their customers’ behalf. In addition, Pass9
provides our game development partners with a simple interface with which to integrate their games into our system.
Our integrated membership management and payment system also incorporates a variety of community-building features,
such as chat rooms, which provide registered users a platform to interact in real-time groups or one-on-one discussions, and bulletin
boards which allow registered users to post notes or inquiries and respond to other users’ notes or inquires. We believe these features
encourage user congregation on our site and facilitate player interaction for the games we offer.
Customer Service
Since our inception, we have continuously focused on providing excellent customer service in order to retain our existing
customers and to attract new customers. Our online games customers can access our customer service center via phone or e-mail at
any time, or visit our visitor center in Shanghai during regular business hours. We have in-game game masters dedicated to each of
the online games that we operate. Game masters are responsible for organizing in-game events, troubleshooting and actively and
continuously monitoring the online game environment. Game masters are available to respond to players’ inquiries, to initiate the bug
reporting and removal processes, as well as to identify, record and deal with players’ inappropriate behavior such as dishonesty, fraud
or other conducts that violates our rules and policies. We believe that positioning game masters to monitor the gaming environment is
important to us to maintain customer loyalty and to efficiently address any technical problems that may arise.
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Purchase of In-game Items
A customer can access online games free of charge and buy in-game items online by charging a payment directly to
Alipay, or by credit card or debit card.
Pricing, Distribution and Marketing
Pricing. We price our in-game virtual items near the end of the free testing period based on several factors, including the
prices of other comparable games, the technological and other features of the game, and the targeted marketing position of the game.
Our prepaid game cards are offered in a variety of denominations to provide users with maximum flexibility.
Distribution. We primarily rely on game platforms and distributors to distribute, promote, market and sell our games in
China and overseas markets, such as North America and Europe. End users can purchase our virtual currencies and prepaid cards
through such game platforms and distributors. A substantial portion of our sales are carried out via such game platforms and
distributors. We do not have long-term agreements with any online game platforms or distributors. In addition, we also directly sell
game points through our game players’ online accounts.
Marketing. Our overall marketing strategy is to rapidly attract new customers and increase revenues from recurring
customers. The marketing programs and promotional activities that we employ to promote our games include:
Advertising and Online Promotion. We place advertisements in many game magazines and on online game sites, which are
updated regularly.
Cross-Marketing. We have cross-marketing relationships with major consumer brands, technology companies and major
telecom carriers. We believe that our cross-marketing relationships with well-known companies will increase the recognition of our
online game brands.
On-Site Promotion. We distribute free game-related posters, promotional prepaid cards for beginners, game-related
souvenirs such as watches, pens, mouse pads and calendars at trade shows, selected Internet cafés and computer stores.
In-Game Marketing. We conduct “in-game” marketing programs from time to time, including online adventures for grand
prizes.
Game Development and Licensing
We believe that the online game industry in China will continue its pattern of developing increasingly sophisticated online
games tailored to the local market. In order to remain competitive, we focus on continuing to develop new proprietary online games,
mobile games and web games. Our product development team is responsible for game design, technical development and art design.
We also plan to further enhance our game development capability and diversify our game portfolio and pipeline.
Our game licensing process begins with a preliminary screening, review and testing of a game, followed by a cost analysis,
negotiations and ultimate licensing of a game, including all regulatory and approval processes. A team is then designated to conduct
“closed beta testing” of the game to resolve operational matters, followed by “open beta testing” during which our registered users
may play the game without removing their in-game data to ensure performance consistency and stability of our operation systems.
Testing generally takes three to six months, during which time we commence other marketing activities.
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Technology
We aim to build a reliable and secure technology infrastructure to fully support our operations, and we maintain separate
technology networks for each of our games. Our current technology infrastructure consists of the following:
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servers and network devices located in four Internet data centers in China as of December 31, 2015;
proprietary software, including game monitor tools, that are integrated with our websites and customer service
center operations; and
hardware platform and server sites primarily consisting of IBM storage systems,HP, H3C and Cisco network
equipment.
We have a network operation team responsible for the stability and security of our network. The team monitors our server
and works to detect, record, analyze and solve problems that arise from out network. In addition, we frequently upgrade our game
server software to ensure the stability of our operations and to reduce the risks of hacking.
Competition
Our major competitors include, but are not limited to, online game operators in China. These include Tencent Holdings
Limited (which operates CrossFire, League of Legends and Dungeon & Fighter), Shanda Games Limited (which operates Woool, Mir
II, Dragon Nest and Million Arthur), NetEase, Inc. (which operates Fantasy Westward Journey, World of Warcraft and Hearthstone:
Heroes of Warcraft), Giant Interactive Group Inc. ( which operates ZT Online and Passion Leads Army Online), Changyou.com
Limited (which operates Dragon Oath 3D and The Legend of Qin II) , Beijing Kunlun Tech Co., Ltd. (which operates Ragnarok
Online, Tales of Swordman and Crazy Horde), Perfect World Co., Ltd. (which operates Perfect World II, Zhu Xian3 and DOTA2)
and NetDragon Websoft Inc. (which operates Moyu, Conquer and Dungeon Keeper Online).
Our existing and potential competitors may compete with us on marketing activities, quality of online games and sales and
distribution networks. Some of our existing and potential competitors have greater financial and marketing resources than us. For a
discussion of risks relating to competition, see “Item 3. Key Information—D. Risk Factors—Risks Related to Our Company and Our
Industry—We may not be able to recover our market share and profitability as we operate in a highly competitive industry and
compete against many companies.”
Intellectual Property
Our intellectual property rights include trademarks and domain names associated with the name “The9” in China and
copyright and other rights associated with our websites, technology platform, self-developed software and other aspects of our
business. We regard our intellectual property rights as critical to our business. We rely on trademark and copyright law, trade secret
protection, non-competition and confidentiality agreements with our employees, and license agreements with our partners, to protect
our intellectual property rights. We require our employees to enter into agreements requiring them to keep confidential all
information relating to our customers, methods, business and trade secrets during and after their employment with us and assign their
inventions developed during their employment to us. Our employees are required to acknowledge and recognize that all inventions,
trade secrets, works of authorship, developments and other processes made by them during their employment are our property.
We have registered our domain names with third-party domain registration entities, and have legal rights over these
domain names through Shanghai IT, our affiliated PRC entity. We conduct our business under the “The9 Limited” brand name and
“The9” logo.
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Legal Proceedings
See “Item 8. Financial Information—A. Consolidated Statements and Other Financial Information—Legal Proceedings.”
Government Regulations
Current PRC laws and regulations impose substantial restrictions on foreign ownership of the online gaming and ICP
businesses in China. As a result, we conduct our online gaming and ICP businesses in China through contractual arrangements with
Shanghai IT, one of our affiliated PRC entities. Shanghai IT is owned by Zhimin Lin and Wei Ji, both of whom are PRC citizens.
In the opinion of our PRC counsel, Zhong Lun Law Firm, subject to the interpretation and implementation of the GAPP
Circular, the ownership structure and the business operation models of our PRC subsidiaries and our affiliated PRC entities comply
with all applicable PRC laws, rules and regulations, and no consent, approval or license is required under any of the existing laws and
regulations of China for their ownership structure and business operation models except for those which we have already obtained or
which would not have a material adverse effect on our business or operations as a whole.
In the online games industry in China, new laws and regulations may be adopted from time to time to require additional
licenses and permits other than those we currently have, and address new issues that arise from time to time. As a result, substantial
uncertainties exist regarding the interpretation and implementation of current and any future PRC laws and regulations applicable to
the online games industry. See “Item 3. Key Information—D. Risk Factors—Risks Related to Doing Business in China—The laws
and regulations governing the online game industry in China are developing and subject to future changes. If we fail to obtain or
maintain all applicable permits and approvals, our business and operations could be materially and adversely affected.”
Regulations on Internet Content Provision Service, Online Gaming and Internet Publishing
Our provision of online game-related content on our websites is subject to various PRC laws and regulations relating to the
telecommunications industry, Internet and online gaming, and is regulated by various government authorities, including MIIT, the
Ministry of Culture, GAPPRFT and the State Administration for Industry and Commerce. The principal PRC regulations governing
the ICP industry as well as the online gaming services in China include:
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•
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Telecommunications Regulations (2000), as amended in 2014;
The Administrative Rules for Foreign Investments in Telecommunications Enterprises (2001), as amended in 2008;
The Administrative Measures for Telecommunications Business Operating License (2009);
The Administrative Measures for Internet Information Services (2000), as amended in 2011;
The Tentative Measures for Administration of Internet Culture (2003), as amended and reissued in 2011;
Administrative Measures on Network Publication (2016);
The Tentative Measures for Administration of Online Games (2010); and
The Foreign Investment Industrial Guidance Catalogue (2015).
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In July 2006, MIIT issued the MII Notice. The MII Notice prohibits ICP license holders from leasing, transferring or
selling a telecommunications business operating license to any foreign investors in any form, or providing any resource, sites or
facilities to any foreign investors for their illegal operation of telecommunications businesses in China. The notice also requires that
ICP license holders and their shareholders directly own the domain names and trademarks used by such ICP license holders in their
daily operations. The notice further requires each ICP license holder to have the necessary facilities for its approved business
operations and to maintain such facilities in the regions covered by its license. In addition, all the value-added telecommunication
service providers are required to maintain network and information security in accordance with the standards set forth under relevant
PRC regulations. The local authorities in charge of telecommunications services are required to ensure that existing ICP license
holders conduct a self-assessment of their compliance with the MII Notice and submit status reports to MIIT before November 1,
2006. For those which are not in compliance with the above requirements and further fail to rectify the situation, the relevant
governmental authorities would have broad discretion to adopt one or more measures against them, including but not limited to
revoking their operating licenses. See “Item 3. Key Information—D. Risk Factors —Risks Related to Our Company and Our
Industry—PRC laws and regulations restrict foreign ownership of Internet content provision, Internet culture operation and network
publication service licenses, and substantial uncertainties exist with respect to the application and implementation of PRC laws and
regulations.”
Under these regulations, a foreign investor is currently prohibited from owning more than 50% of the equity interest in a
PRC entity that provides value-added telecommunications services (except for e-commerce services). ICP services are classified as
value-added telecommunications businesses, and a commercial operator of such services must obtain an ICP License from the
appropriate telecommunications authorities in order to carry on any commercial ICP operations in China.
With respect to the online gaming industry in China, since online games fall into the definition of “Internet culture
products” under The Tentative Measures for Administration of Internet Culture (2011), a commercial operator of online games must,
in addition to obtaining the ICP License, obtain an Internet culture operation license from the appropriate culture administrative
authorities for its operation of online games. Furthermore, according to The Tentative Measures for Administration of Internet
Publication (2002), the provision of online games is deemed an Internet publication activity. Therefore, approval from the appropriate
press and publication administrative authorities as an Internet publisher or cooperation with a licensed Internet publisher is required
for an online game operator to carry on its online gaming businesses in China. In February 2016, the GAPPRFT and the MIIT jointly
issued the Administrative Measures on Network Publication, which took effect in March 2016 and replaced the Tentative
Administrative Measures on Internet Publication. The Administrative Measures on Network Publication further strengthen and
expand the supervision and management on the network publication service, including online games service. Furthermore, online
games, including mobile games, regardless of whether imported or domestic, shall be subject to a content review and approval by or a
filing with the Ministry of Culture and GAPPRFT prior to commencement of operations in China.
GAPPRFT and MIIT jointly impose a license requirement for any company that intends to engage in network publishing,
defined as any activity of providing network publications to the public through information networks. Network publications refer to
the digitalized works with publishing features such as editing, producing and processing. Furthermore, the distribution of online game
cards and CD-keys for online gaming programs is subject to a licensing requirement. Shanghai IT holds the license necessary to
distribute electronic publications, which allows it to distribute prepaid cards and CD-Keys for the games we operate. We sell our
prepaid cards and CD-Keys through third-party distributors, which are responsible for maintaining requisite licenses for distributing
our prepaid cards and CD Keys in China.
On February 15, 2007, fourteen governmental authorities, including the Ministry of Culture, MIIT, the State
Administration for Industry and Commerce, and the People’s Bank of China, or the PBOC, jointly issued a circular entitled Circular
for Further Strengthening the Administration of Internet Café and Online Games. This circular gave the PBOC administrative
authority over virtual currencies issued by online game operators for use by players in online games to avoid the potential impact
such virtual currencies may have on the real-world financial systems. According to this circular, the volume that may be issued and
the purchase of such virtual currencies must be restricted, and virtual currency must not be used for the purchase of any physical
products, refunded with a premium or otherwise illegally traded. The Notice of Strengthening the Management of Virtual Currency of
Online Games promulgated by the Ministry of Culture and MOFCOM on June 4, 2009 and the Tentative Measures for
Administration of Online Games promulgated by the Ministry of Culture on June 3, 2010 impose more restrictions and requirements
on online game operators that issue virtual currencies. According to the above regulations, an online game operator which issues
virtual currency used for online game services shall apply for approval from the Ministry of Culture. An online game operator shall
further report detailed rules of issuance for virtual currencies, such as distribution scope, pricing, and terms for refunds and shall
make certain periodic and supplementary filings as required by the relevant regulations. In addition, under the new rules, online game
operators are prohibited from assigning game tools or virtual currency to users by way of drawing lots, random samplings or other
arbitrary means in exchange for users’ cash or virtual currency. The new rules also require that service agreements entered into
between online game operators and end users contain the general terms of a standard online game service agreement issued by the
Ministry of Culture.
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In September 2009, GAPP further promulgated the GAPP Circular, which provides that foreign investors are prohibited
from making investment and engaging in online game operation services by setting up foreign-invested enterprises in China. Further,
foreign investors shall not control and participate in PRC online game operation businesses indirectly or in a disguised manner by
establishing joint venture companies or entering into agreements with or providing technical support to such PRC online game
operation companies, or by inputting the users’ registration, account management, game cards consumption directly into the
interconnected gaming platform or fighting platform controlled or owned by the foreign investor. It is not clear whether the regulatory
authority of GAPPRFT applies to the regulation of ownership structures of online game companies based in China and online game
operation in China. Other government agencies that have regulatory jurisdiction over the online game operations in China, such as the
Ministry of Culture and MIIT, did not join GAPP in issuing the GAPP Circular. To date, GAPPRFT has not issued any interpretation
of the GAPP Circular. It is not yet clear how this GAPP Circular will be implemented. The relevant governmental authorities have
broad discretion to adopt one or more of administrative measures against companies now in compliance with these measures,
including revoking relevant licenses and relevant registration. See “Item 3. Key Information—D. Risk Factors—Risks Related to Our
Company and Our Industry—PRC laws and regulations restrict foreign ownership of Internet content provision, Internet culture
operation and network publication service licenses, and substantial uncertainties exist with respect to the application and
implementation of PRC laws and regulations.”
The operation of SMS in China is classified as a value-added telecommunication business and SMS service providers shall
obtain the relevant value-added telecommunication business permits.
Regulations on Internet Content
The PRC government has promulgated measures relating to Internet content through a number of ministries and agencies,
including MIIT, the Ministry of Culture and GAPPRFT. These measures specifically prohibit Internet activities, including the
operation of online games that result in the publication of any content which is found to, among other things, propagate obscenity,
gambling or violence, instigate crimes, undermine public morality or the cultural traditions of the PRC, or compromise State security
or secrets. See “Item 3. Key Information—D. Risk Factors—Risks Related to Doing Business in China—The laws and regulations
governing the online game industry in China are developing and subject to future changes. If we fail to obtain or maintain all
applicable permits and approvals, our business and operations could be materially and adversely affected.” If an ICP license holder
violates these measures, the PRC government may revoke its ICP license and shut down its websites.
In April 2007, various governmental authorities, including GAPP, MIIT, the Ministry of Education, the Ministry of Public
Security, and other relevant authorities jointly issued a circular concerning the mandatory implementation of an “anti-fatigue system”
in online games, which was aimed at protecting the physical and psychological health of minors. This circular required all online
games to incorporate an “anti-fatigue system” and an identity verification system, both of which have limited the amount of time that
a minor or other user may continuously spend playing an online game. We have implemented such “anti-fatigue” and identification
systems on all of our online games as required. Since March 2011, various governmental authorities, including the Ministry of
Culture, MIIT, the Ministry of Education, the Ministry of Public Security, and other relevant authorities have jointly launched the
“Online Game Parents Guardianship Project for Minors,” which allows parents to require online game operators to take relevant
measures to limit the time spent by the minors on playing online games and the minors’ access to their online game accounts. On
February 5, 2013, the Ministry of Culture, MIIT, GAPP and various other governmental authorities, jointly issued the Working Plan
on the Comprehensive Prevention Scheme on Online Game Addiction of Minors, which further strengthened the administration of the
Internet cafés, reinstated the importance of the “anti-fatigue system” and “Online Game Parents Guardianship Project for Minors” as
prevention measures against the online game addiction of minors and ordered all relevant governmental authorities to take all
necessary actions in implementing such measures. Additional requirements for anti-fatigue and identification systems in our games,
as well as the implementation of any other measures required by any new regulations the PRC government may enact to further
tighten its administration of the Internet and online games, and its supervision of Internet cafés, may limit or slow down our prospects
for growth, or may materially and adversely affect our business results. See “Item 3. Key Information—D. Risk Factors—Risks
Related to Doing Business in China—Our business may be adversely affected by public opinion and government policies in China.”
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Internet content in China is also regulated and restricted from a state security standpoint. The National People’s Congress,
China’s national legislative body, has enacted a law that may subject to criminal punishment in China any effort to: (1) gain improper
entry into a computer or system of strategic importance; (2) disseminate politically disruptive information; (3) leak state secrets; (4)
spread false commercial information; or (5) infringe intellectual property rights.
The Ministry of Public Security has promulgated measures that prohibit the use of the Internet in ways which, among other
things, results in a leakage of state secrets or a spread of socially destabilizing content. The Ministry of Public Security has
supervision and inspection rights in this regard, and we may be subject to the jurisdiction of the local security bureaus. See “Item 3.
Key Information—D. Risk Factors—Risks Related to Doing Business in China—Regulation and censorship of information
disseminated over the Internet in China may adversely affect our business, and we may be liable for information displayed on,
retrieved from, or linked to our Internet websites.” If an ICP license holder violates these measures, the PRC government may revoke
its ICP license and shut down its websites.
Regulations on Internet Cafés
Internet cafés are required to obtain a license from the Ministry of Culture and the State Administration for Industry and
Commerce, and are subject to requirements and regulations with respect to location, size, number of computers, age limit of
customers and business hours. Although we do not own or operate any Internet cafés, many Internet cafés distribute our virtual pre-
paid cards. The PRC government has enacted laws to intensify its regulation and administration of Internet cafés, which are currently
the primary venue for our users to play online games. Intensified government regulation of Internet cafés could restrict our ability to
maintain or increase our revenues and expand our customer base. See “Item 3. Key Information—D. Risk Factors—Risks Related to
Doing Business in China—Intensified government regulation of Internet cafés could limit our ability to maintain or increase our
revenues and expand our customer base.”
Regulations on Privacy Protection
PRC laws and regulations do not prohibit Internet content providers from collecting and analyzing personal information
from their users subject to the user’s prior consent. We require our users to accept a user agreement whereby they agree to provide
certain personal information to us. PRC law prohibits Internet content providers from disclosing to any third parties any information
transmitted by users through their networks unless otherwise permitted by law. If an Internet content provider violates these
regulations, it may be liable for damages caused to its users and it may be subject to administrative penalties such as warnings, fines,
confiscation of its unlawful income, revocation of licenses, cancellation of filings, shutdown of their websites or even criminal
liabilities.
Import Regulations
Our ability to obtain licenses for online games from abroad and import them into China is regulated in several ways. We
are required to register with MOFCOM any license agreement with a foreign licensor that involves an import of technologies,
including online game software into China. Without that registration, we may not remit licensing fees out of China to any foreign
game licensor. In addition, the Ministry of Culture requires us to submit for its content review and/or approval any online games we
want to license from overseas game developers or any patch or updates for such game if it contains substantial changes. If we license
and operate games without that approval, the Ministry of Culture may impose penalties on us, including revoking the Internet culture
operation license required for the operation of online games in China. Also, pursuant to a jointly issued notice in July 2004, GAPP
and the State Copyright Bureau require us to obtain their approval for imported online game publications. Furthermore, the State
Copyright Bureau requires us to register copyright license agreements relating to imported software. Without the State Copyright
Bureau registration, we cannot remit licensing fees out of China to any foreign game licensor and we are not allowed to publish or
reproduce the imported game software in China.
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Regulations on Intellectual Property Rights
The State Council and the State Copyright Bureau have promulgated various regulations and rules relating to the protection
of software in China. Under these regulations and rules, software owners, licensees and transferees may register their rights in
software with the State Copyright Bureau or its local branches and obtain software copyright registration certificates. Although such
registration is not mandatory under PRC law, software owners, licensees and transferees are encouraged to go through the registration
process and registered software rights may receive better protection. We have registered all of our in-house developed online games
with the State Copyright Bureau.
Regulations on Foreign Currency Exchange and Dividend Distribution
Foreign Currency Exchange. Foreign currency exchange regulation in China is primarily governed by the following rules:
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Foreign Exchange Administration Rules (1996), as amended in 1997 and 2008; and
Administration Rules of the Settlement, Sale and Payment of Foreign Exchange (1996).
Pursuant to the Foreign Exchange Administration Rules (1996), as amended in 1997 and 2008, the RMB is generally freely
convertible for trade and service-related foreign exchange transactions, but not for direct investment, loans, investment in securities,
or other transactions through a capital account outside China unless the prior approval of SAFE is obtained. Furthermore, foreign
investment enterprises in China in general may purchase foreign exchange without the approval of SAFE for trade and service-related
foreign exchange transactions by providing commercial documents evidencing these transactions. Foreign investment enterprises that
need foreign exchange for the distribution of profits to their shareholders may effect payment from their foreign exchange account or
purchase and pay foreign exchange at the designated foreign exchange banks to their foreign shareholders by producing board
resolutions for such profit distribution. Under the Administration Rules of the Settlement, Sale and Payment of Foreign Exchange
(1996), based on their needs, foreign investment enterprises are permitted to open foreign exchange settlement accounts for current
account receipts and payments of foreign exchange along with specialized accounts for capital account receipts and payments of
foreign exchange at certain designated foreign exchange banks.
On November 19, 2012, SAFE promulgated the Circular of Further Improving and Adjusting Foreign Exchange
Administration Policies on Foreign Direct Investment, or SAFE Circular 59, which became effective on December 17, 2012. The
major developments under SAFE Circular 59 were that the opening of various special purpose foreign exchange accounts (e.g. pre-
establishment expenses account, foreign exchange capital account, guarantee account) no longer required the approval of SAFE.
Furthermore, multiple capital accounts for the same entity may be opened in different provinces, which was not possible before the
issuance of SAFE Circular 59. Reinvestment of RMB proceeds by foreign investors in the PRC no longer required SAFE approval or
verification, and remittance of foreign exchange profits and dividends by a foreign-invested enterprise to its foreign shareholders no
longer required SAFE approval.
On May 10, 2013, SAFE promulgated the Circular on Printing and Distributing the Provisions on Foreign Exchange
Administration over Domestic Direct Investment by Foreign Investors and the Supporting Documents, which specifies that the
administration by SAFE or its local branches over direct investment by foreign investors in the PRC shall be based on registration.
Institutions and individuals shall register with SAFE and/or its branches for their direct investment in the PRC. Banks shall process
foreign exchange business relating to the direct investment in the PRC based on the registration information provided by SAFE and
its branches.
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On February 13, 2015, SAFE issued the Circular on Further Simplifying and Improving the Foreign Exchange
Administration Policies on Direct Investments, or SAFE Circular 13, which took effect on June 1 2015. Pursuant to SAFE Circular
13, the administrative examination and approval procedures with SAFE or its local branches relating to the foreign exchange
registration approval for domestic direct investments as well as overseas direct investments have been cancelled, and qualified banks
are delegated the power to directly conduct such foreign exchange registrations under the supervision of SAFE or its local branches.
Dividend Distribution. The principal regulations governing distribution of dividends of foreign holding companies include:
•
•
The Wholly Foreign Invested Enterprise Law (1986), as amended in 2000; and
Administrative Rules under the Wholly Foreign Invested Enterprise Law (1990), as amended in 2001 and 2014.
Under these regulations, foreign investment enterprises in China may pay dividends only out of their accumulated profits,
if any, determined in accordance with PRC accounting standards and regulations. In addition, foreign investment enterprises in China
are required to allocate at least 10% of their respective profits each year, if any, to fund certain reserve funds until the cumulative
total of the allocated reserve funds reaches 50% of an enterprise’s registered capital and a portion of their respective after-tax profits
to their staff welfare and bonus reserve funds as determined by their respective board of directors or shareholders. These reserves are
not distributable as dividends.
Regulations on Foreign Exchange in Certain Onshore and Offshore Transactions
On July 4, 2014, SAFE issued SAFE Circular 37, which is the Circular on Several Issues Concerning Foreign Exchange
Administration of Domestic Residents Engaging in Overseas Investment, Financing and Round-Trip Investment via Special Purpose
Vehicles. SAFE Circular 37 and its detailed guidelines require PRC residents to register with the local branch of SAFE before
contributing their legally owned onshore or offshore assets or equity interest into any SPV directly established, or indirectly
controlled, by them for the purpose of investment or financing. In addition, when there is (a) any change to the basic information of
the SPV, such as any change relating to its individual PRC resident shareholders, name or operation period or (b) any material
change, such as increase or decrease in the share capital held by its individual PRC resident shareholders, a share transfer or exchange
of the shares in the SPV, or a merger or split of the SPV, the PRC resident must register such changes with the local branch of SAFE
on a timely basis. According to the relevant SAFE rules, failure to comply with the registration procedures set forth in SAFE Circular
37 may result in restrictions being imposed on the foreign exchange activities of the relevant onshore companies of SPVs, including
the payment of dividends and other distributions to its offshore parent or affiliate and the capital inflow from such offshore entity, and
may also subject the relevant PRC residents and onshore companies to penalties under PRC foreign exchange administration
regulations. Further, failure to comply with various SAFE registration requirements described above would result in liability for
foreign exchange evasion under PRC laws. On February 13, 2015, SAFE issued SAFE Circular 13, which is the Circular on Further
Simplifying and Improving the Foreign Exchange Administration Policies on Direct Investments, which took effect on June 1, 2015.
Under SAFE Circular 13, qualified banks are delegated the power to register all PRC residents’ investments in SPVs pursuant to
SAFE Circular 37, saving for supplementary registration application made by PRC residents who failed to comply with SAFE
Circular 37, which shall still fall into the jurisdiction of the local branch of SAFE.
As a result of the uncertainties relating to the interpretation and implementation of SAFE Circular 37 and SAFE Circular
13, we cannot predict how these regulations will affect our business operations or strategies. For example, our present or future PRC
subsidiaries’ ability to conduct foreign exchange activities, such as remittance of dividends and foreign-currency-denominated
borrowings, may be subject to compliance with such SAFE registration requirements by relevant PRC residents, over whom we have
no control. In addition, we cannot assure you that any such PRC residents will be able to complete the necessary approval and
registration procedures required by the SAFE regulations. We have requested all of our shareholders who, based on our knowledge,
are PRC residents or whose ultimate beneficial owners are PRC residents to comply with all applicable SAFE registration
requirements, but we have no control over our shareholders. We cannot assure you that the PRC beneficial owners of our company
and our subsidiaries have completed the required SAFE registrations. Nor can we assure you that they will be in full compliance with
the SAFE registration in the future. Any non-compliance by the PRC beneficial owners of our company and our subsidiaries may
subject us or such PRC resident shareholders to fines and other penalties. It may also limit our ability to contribute additional capitals
to our PRC subsidiaries and our subsidiaries’ ability to distribute profits or make other payments to us.
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C. Organizational Structure
The following diagram illustrates our organizational structure, the place of formation, ownership interest of each of our
significant subsidiaries and affiliated entities that operate our major game platforms in China as of the date of this annual report:
D. Property, Plants and Equipment
Our headquarters are located on premises comprising approximately 14,000 square meters in an office building in
Shanghai, China. We purchased the office building in which our headquarters are located, and lease all of our other premises from
unrelated third parties. Our office building has been mortgaged to secure the Convertible Notes in the aggregate principal amount of
US$40,050,000 issued and sold to Splendid Days and an entrusted loan of approximately RMB31.6 million (US$4.9 million) that we
obtained from a third party in December 2015. In addition, we have subsidiaries located in the United States, Singapore and South
Korea and small branch offices in Beijing, Nanjing, Wuhan, Xi’an, Chengdu and Shenyang, China. Our equipment consists
substantially of numerous servers and network devices located in four Internet data centers in China.
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Item 4A.
UNRESOLVED STAFF COMMENTS
None.
Item 5.
OPERATING AND FINANCIAL REVIEW AND PROSPECTS
The following discussion of our financial condition and results of operations is based upon and should be read in
conjunction with our consolidated financial statements and their related notes included in this annual report. This report contains
forward-looking statements. See “—G. Safe Harbor.” In evaluating our business, you should carefully consider the information
provided under the caption “Risk Factors” in this annual report. We caution you that our businesses and financial performance are
subject to substantial risks and uncertainties.
A. Operating Results
The major factors affecting our results of operations and financial conditions include:
•
•
•
our revenues’ composition and sources of revenues;
our cost of revenue; and
our operating expenses.
Revenue Composition and Sources of Revenue. In 2013, 2014 and 2015, we generated substantially all of our revenues
from online game services, and the remaining portion of our revenues from other services. The following table sets forth our revenues
generated from providing online game services and other services, both as absolute amounts and as percentages of total revenues for
the periods indicated.
Revenue:
Online game services
Other revenues
Total revenues
For the Year Ended December 31,
2013
RMB
% RMB
2014
2015
% RMB US$
%
(in thousands, except percentages)
95,131 89.2 55,418 85.5 40,504 6,253 86.9
11,496 10.8 9,422 14.5 6,106 943 13.1
106,627 100.0 64,840 100.0 46,610 7,196 100.0
Online Game Services. In 2013, 2014 and 2015, revenues from our online game services amounted to RMB95.1 million,
RMB55.4 million and RMB40.5 million (US$6.3 million), respectively. We primarily generate our online game service revenues
through item-based revenue models. Under an item-based revenue model, players of our games play the games for free, but are
charged for purchases of in-game items, such as performance-enhancing items, clothing and accessories. Thus, we generate revenues
through the sale of such in-game premium features that players use game points to purchase. The distribution of points to end users is
typically made through sales of prepaid game cards and prepaid online points. Fees from prepaid game cards and prepaid online
points are deferred when initially received. This revenue is recognized over the life of the premium features or as the premium
features are consumed. Future usage patterns may differ from the historical usage patterns on which the virtual items and services
consumption model is based. We will continue to monitor the operational statistics and usage patterns affecting our recognition of
these revenues.
Other Revenues. Other revenues mainly included revenues from mobile advertisement and trainings.
Cost of Revenue. Our cost of revenue consists of costs directly attributable to rendering our services, including online
game royalties, payroll, sharing to third party game platform, telecom carries and other suppliers, depreciation and rental of Internet
data center sites, depreciation and amortization of computer equipment and software, intangible assets amortization and other
overhead expenses directly attributable to the services we provide.
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Operating Expenses. Our operating expenses consist primarily of product development expenses, sales and marketing
expenses, general and administrative expenses, impairment on equipment, intangible assets and other long-lived assets and allowance
on long-term receivables.
Product Development Expenses. Our product development expenses consist primarily of compensation to our product
development personnel, outsourced research and development expenses, equipment and software depreciation charges and other
overhead expenses for the development of our proprietary games. Our product development expenses amounted to RMB213.2
million, RMB156.3 million and RMB135.0 million (US$20.8 million) for the years ended December 31, 2013, 2014 and 2015,
respectively. Most of our proprietary online games have entered into their final stages of development and we have ability to control
the level of discretionary spending on product development in the near future.
Sales and Marketing Expenses. Our sales and marketing expenses consist primarily of advertising and marketing expenses
incurred to promote our games and compensation expenses relating to our sales and marketing personnel. Our sales and marketing
expenses amounted to RMB116.7 million, RMB51.8 million and RMB31.7 million (US$4.9 million) for the years ended December
31, 2013, 2014 and 2015, respectively.
General and Administrative Expenses. Our general and administrative expenses consist primarily of compensation and
travel expenses for our administrative staff, depreciation of property and equipment, entertainment expenses, administrative office
expenses, as well as fees paid to professional service providers for auditing and legal services. General and administration expenses
amounted to RMB162.0 million, RMB111.2 million and RMB131.8 million (US$20.3 million) for the years ended December 31,
2013, 2014 and 2015, respectively. General and administrative expenses continued to decrease from 2013 to 2015 reflecting our cost
cutting efforts. We expect general and administrative expenses including share-based compensation expenses will remain relatively
stable at the current level in the near future.
Impairment on Long-lived Assets. Impairment charges relate to the impairment on certain equipment and intangible assets
amounting to RMB5.7 million, nil and nil for the years ended December 31, 2013, 2014 and 2015, respectively.
(Provision) Reversal of Provision for Allowance for Long-term Receivables and Prepayments. We recorded allowance on
long-term receivable of RMB29.7 million, RMB3.6 million and RMB8.4 million (US$1.3 million) for the years ended December 31,
2013, 2014 and 2015, respectively. We reversed the provision of RMB17.9 million for the year ended December 31, 2014. The
allowance on long-term receivable in 2013 was primarily due to certain prepayment made to an equipment supplier. In 2014, we
reversed all such allowance as we reevaluated the collectability of the receivables and determined that the payments can be collected.
We collected the amount in full in 2015. The allowance on long-term receivable in 2015 was related to the receivable from WoW
game points refund agent.
Gain/loss on Disposal of Subsidiaries. We recorded a gain on disposal of a subsidiary of RMB3.3 million (US$0.5 million)
in October 2015 in connection with the disposal of 58% equity interest in Shanghai Jiucheng Advertisement, which operates our
mobile advertising platform. We recorded a gain on disposal of subsidiaries disposal of RMB165.4 million in 2014 in connection
with disposal of our equity interests in Huopu Cloud and Shanghai Kai Yue Information Technology Co. Ltd., or Kai Yue. We did
not record any gain on disposal of subsidiaries in 2013.
Other Operating Income (Expenses). We had operating expenses of RMB1.6 million (US$0.2 million) in 2015,
representing a loss on disposal of property, equipment and software. Our other operating income in 2013 and 2014 represented rental
income, which amounted to RMB120,000 and RMB75,000, respectively.
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Holding Company Structure
We are a holding company incorporated in the Cayman Islands and rely primarily on dividends and other distributions
from our subsidiaries and our affiliated entities in China for our cash requirements. Current PRC regulations restrict our affiliated
entities and subsidiaries from paying dividends in the following two principal aspects: (i) our affiliated entities and subsidiaries in
China are only permitted to pay dividends out of their respective accumulated profits, if any, determined in accordance with PRC
accounting standards and regulations; and (ii) these entities are required to allocate at least 10% of their respective accumulated
profits each year, if any, to fund certain capital reserves until the cumulative total of the allocated reserves reach 50% of registered
capital, and a portion of their respective after-tax profits to their staff welfare and bonus reserve funds as determined by their
respective boards of directors. These reserves are not distributable as dividends. See “Item 4. Information on the Company—B.
Business Overview—Government Regulations.” In addition, failure to comply with relevant SAFE regulations may restrict the ability
of our subsidiaries to make dividend payments to us. See “Item 3. Key Information—D. Risk Factors—Risks Related to Doing
Business in China —PRC regulations relating to the establishment of offshore special purpose companies by PRC residents may
subject our PRC resident shareholders or us to penalties and fines, and limit our ability to inject capital into our PRC subsidiaries,
limit our subsidiaries’ ability to increase their registered capital, distribute profits to us, or otherwise adversely affect us.”
Income and Sales Taxes
The National People’s Congress of the PRC adopted and promulgated the EIT Law on March 16, 2007. The EIT Law went
into effect as of January 1, 2008, and unified the tax rate generally applicable to both domestic and foreign-invested enterprises in the
PRC. Our company’s subsidiaries and affiliated entities in the PRC are generally subject to EIT at a statutory rate of 25%. Our
subsidiaries and affiliated entities in the PRC that hold a HNTE qualification are entitled to enjoy a 15% preferential EIT rate.
In addition, under the EIT Law, enterprises organized under the laws of their respective jurisdictions outside the PRC may
be classified as either “non-resident enterprises” or “resident enterprises.” Non-resident enterprises are subject to withholding tax at
the rate of 20% with respect to their PRC-sourced dividend income if they have no establishment or place of business in the PRC or if
such income is not related to their establishment or place of business in the PRC, unless otherwise exempted or reduced according to
treaties or arrangements between the PRC central government and the governments of other countries or regions. The State Council
has reduced the withholding tax rate to 10% in the newly promulgated implementation rules of the EIT Law. As we are incorporated
in the Cayman Islands, we may be regarded as a “non-resident enterprise.” We hold equity interests in certain PRC subsidiaries
through subsidiaries in Hong Kong. According to the Tax Agreement between the PRC and Hong Kong, dividends paid by a foreign-
invested enterprise in the PRC to its corporate shareholder in Hong Kong holding 25% or more of its equity interest may be subject to
withholding tax at the maximum rate of 5% if certain criteria are met. Entitlement to such lower tax rate on dividends according to tax
treaties or arrangements between the PRC central government and governments of other countries or regions is further subject to
approval of relevant tax authority.
Furthermore, the SAT promulgated Circular 601 which provides guidance for determining whether a resident of a
contracting state is the “beneficial owner” of an Item of income under China’s tax treaties and tax arrangements. According to
Circular 601, a beneficial owner generally must be engaged in substantial business activities. An agent or conduit company will not
be regarded as a beneficial owner and, therefore, will not qualify for treaty benefits. The conduit company normally refers to a
company that is set up for the purpose of avoiding or reducing taxes or transferring or accumulating profits. In June 2012, SAT
further promulgated Circular 30 which provides that the tax authorities shall make the decision based on comprehensive consideration
of all determining factors provided in Circular 601 rather than the status of a single determining factor. We cannot assure you that any
dividends to be distributed by us or by our subsidiaries to our non-PRC shareholders and ADS holders whose jurisdiction of
incorporation has a tax treaty with China providing a different withholding arrangement will be entitled to the benefits under the
relevant withholding arrangement.
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The EIT law deems an enterprise established offshore but having its management organ in the PRC as a “resident enterprise”
that will be subject to PRC tax at the rate of 25% of its global income. Under the Implementation Rules of the New Enterprise Income
Tax Law, the term “management organ” is defined as “an organ which has substantial and overall management and control over the
manufacturing and business operation, personnel, accounting, properties and other factors.” On April 22, 2009, the SAT further issued
Circular 82. According to Circular 82, a foreign enterprise controlled by a PRC company or a PRC company group shall be deemed a
PRC resident enterprise, if (i) the senior management and the core management departments in charge of its daily operations are mainly
located and function in the PRC; (ii) its financial decisions and human resource decisions are subject to the determination or approval of
persons or institutions located in the PRC; (iii) its major assets, accounting books, company seals, minutes and files of board meetings
and shareholders’ meetings are located or kept in the PRC; and (iv) more than half of the directors or senior management with voting
rights reside in the PRC. On July 27, 2011, SAT issued SAT Bulletin 45 which further clarified the detailed procedures for
determination of the resident status provided in Circular 82, competent tax authorities in charge and post-determination administration
of such resident enterprises. Although our offshore companies are not controlled by any PRC company or PRC company group, we
cannot assure you that we will not be deemed to be a “resident enterprise” under the EIT Law and thus be subject to PRC EIT on our
global income.
According to the EIT Law and its implementation rules, dividends are exempted from income tax if such dividends are
received by a PRC resident enterprise on equity interests it directly owns in another PRC resident enterprise. However, foreign corporate
holders of our shares or ADSs may be subject to taxation at a rate of 10% on any dividends received from us or any gains realized from
the transfer of our shares or ADSs if we are deemed to be a resident enterprise or if such income is otherwise regarded as income
“sourced within the PRC.” See “Item 3. Key Information—D. Risk Factors—Risks Related to Our Company and Our Industry—The
PRC income tax laws may increase our tax burden or the tax burden on the holders of our shares or ADSs, and tax benefits available to
us may be reduced or repealed, causing the value of your investment in us to suffer.”
With respect to sales taxes, before December 31, 2011, all the services provided by our PRC subsidiaries were subject to
business taxes at the rate of 5%. In October, 2011, China’s Ministry of Finance and the SAT jointly issued the Circular 110 to launch the
VAT reform pilot program in Shanghai. Following the Circular 110, the Ministry of Finance and the SAT jointly issued the Circular 111
in November 2011 to provide detailed implementation rules for the program. The two circulars, which would be effective from January
1, 2012, stipulated that certain services, subject to the pilot programs, shall be subject to VAT instead of business tax. On July 31, 2012,
the Ministry of Finance and the SAT jointly issued Circular 71 which further extended areas subject to the pilot program to eight more
provinces. On December 12, 2013, the Ministry of Finance and the SAT jointly issued the Interim Implementation Rules on the Pilot
Program for the Collection of Value Added Tax Instead of Business Tax and a series of other rules, which annulled the preceding trial
rules and extended applicable areas of the pilot program to the whole country. As a result of such Implementation Rules, some of our
services provided by Shanghai IT and The9 Computer are subject to VAT at the rate of 6%. Shanghai IT and The9 Computer, as
General VAT Payers under the applicable tax regulations, may reduce their Input VAT. Certain services provided by Shanghai The9
Education Technology Co., Ltd. and other PRC subsidiaries or affiliated PRC entities shall be subject to VAT at the rate of 3%, and
these companies as Small-scale VAT Payers under the applicable tax regulations may not reduce their VAT payable by their Input VAT.
On March 23, 2016, the Ministry of Finance and the SAT jointly issued the Circular on the Pilot Program for Overall
Implementation of the Collection of Value Added Tax Instead of Business Tax, or Circular 36, which will take effect on May 1, 2016.
Pursuant to Circular 36, all companies operating in construction, real estate, finance, modern service or other sectors which were
required to pay business tax are required to pay VAT in lieu of business tax. As a result of Circular 36, the services provided by
Shanghai IT, The9 Computer, C9I Shanghai, Shanghai Fire Wing and The9 Education as general VAT payers will be subject to VAT at
the rate of 6%, and the services provided by our other PRC subsidiaries or affiliated PRC entities as small-scale VAT payers will be
subject to VAT at the rate of 3%.
Our subsidiaries in the United States are registered in California and are subject to U.S. federal corporate marginal income
tax at a rate of 34% and state income tax at a rate of 0.48%, respectively.
Critical Accounting Policies
We prepare financial statements in conformity with U.S. Generally Accepted Accounting Principles, or U.S. GAAP, which
requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets
and liabilities on the date of the financial statements, and the reported amounts of revenue and expenses during the financial reporting
period. We continually evaluate these estimates and assumptions based on the most recently available information, our own historical
experience and various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis
for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Since the use of
estimates is an integral component of the financial reporting process, actual results could differ from those estimates. Some of our
accounting policies require higher degrees of judgment than others in their application. We consider the policies discussed below to be
critical to an understanding of our financial statements as their application assists management in making their business decisions.
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Consolidation of Variable Interest Entities, or VIEs
PRC laws and regulations, including the GAPP Circular, currently prohibit or restrict foreign ownership of Internet-related
businesses. We believe, consistent with the view of our PRC legal counsel, that our current structure complies with these foreign
ownership restrictions, subject to the interpretation and implementation of the GAPP Circular. Specifically, we operate our business
through Shanghai IT and have entered into a series of contractual arrangements with Shanghai IT and its equity owners. See the
contractual arrangements set forth in “Item 7. Major Shareholders and Related Party Transactions—B. Related Party Transactions.”
As a result of these contractual arrangements, we are entitled to receive service fees for services provided to Shanghai IT for an
amount determined at our discretion, up to 90% of PRC entities’ profits. In addition, the equity owners of record for these entities
have pledged all their equity interests in the VIEs to us as collateral for all of their payments due to the wholly-owned foreign
enterprise, or WOFE, and to secure performance of all obligations of the VIEs and their shareholders under various agreements. In
addition, the agreements provide that any dividend distributions made by the VIEs, if any, are required to be deposited in an escrow
account over which we have exclusive control. Moreover, through the Call Option Agreements and Shareholder Voting Proxy
Agreements, each shareholder of the VIEs granted WOFE or any third parties designated by the WFOE an irrevocable power of
attorney to act on all matters pertaining to the VIEs. We believe that the terms of the Call Option Agreements are currently
exercisable and legally enforceable under the PRC laws and regulations. We also believe that the minimum amount of consideration
permitted by the applicable PRC law to exercise the options does not represent a financial barrier or disincentive for us to exercise our
rights under the Call Option Agreements. A simple majority vote of our board of directors is required to pass a resolution to exercise
our rights under the Call Option Agreements, for which consent of the shareholder of the VIEs is not required. As a result of the
totality of these arrangements, we have both the power to direct activities that most significantly impact the VIEs economic
performance and the obligation to absorb losses of or right to receive benefits from the VIEs that are significant to Shanghai IT. As a
result, we concluded we are the primary beneficiary of Shanghai IT and as such Shanghai IT is consolidated VIE of our company.
The GAPP Circular reiterates and reinforces the long-standing prohibition of foreign ownership of Internet-related
publication businesses via direct, indirect or disguised methods. However, it is not clear whether the regulatory authority of
GAPPRFT applies to the regulation of ownership structures of online game companies based in China and online game operation in
China. In addition, the GAPP Circular does not specifically invalidate VIE agreements, and we are not aware of any online game
companies adopting similar contractual arrangements as ours having been penalized or ordered to terminate such arrangements since
the GAPP Circular first became effective. Therefore, we believe that our ability to direct the activities of Shanghai IT that most
significantly impact our economic performance is not affected by the GAPP Circular. Any changes in PRC laws and regulations that
affect our ability to control Shanghai IT might preclude us from consolidating Shanghai IT in the future. See “Item 3. Key
Information—D. Risk Factors—Risks Related to Our Company and Our Industry—PRC laws and regulations restrict foreign
ownership of Internet content provision, Internet culture operation and network publication service licenses, and substantial
uncertainties exist with respect to the application and implementation of PRC laws and regulations.”
Revenue Recognition
Online Game Services
We earn revenue from provision of online game operation services to players on our game servers and third party platform
and overseas licensing of the online game to other operators. We recognize revenues when persuasive evidence of an arrangement
exists, services are delivered or performed, our price is fixed or determinable and collectability is reasonably assured.
Online game services to players on our game server
We generate revenue primarily from the sale of our prepaid game cards and prepaid online points for our online game
services products to distributors who in turn ultimately sell them to players. We also sell the points directly to players via certain
online payment platforms.
53
We utilize a virtual item/service consumption model to recognize revenue. Under this model, we generate online game
service revenues through the sale of in-game premium features. In this model, players can access our basic games free of charge and
then may purchase game points to acquire in-game premium features. The distribution of points to players is typically made through
sales of prepaid game cards and prepaid online points. Fees for prepaid game cards and prepaid online points are deferred when
initially received. This revenue is recognized over the estimated life of the premium features or as the premium features are
consumed.
For in-game premium features that are immediately consumed, revenue is recognized upon consumption. For premium
features with a stated expiration time, which ranges from one to 180 days, revenue is recognized ratably over the period starting from
when the feature is first used to the expiration time. For perpetual features with no predetermined expiration, revenue is recognized
ratably over the estimated average lives of the perpetual features, which are typically less than one year. When estimating the average
lives of the in-game perpetual features, we consider the average period that players typically play the game, other player behavior
patterns, and factors including the acceptance and popularity of expansion packs, promotional events launched, and market
conditions. Future usage patterns of players may differ from the historical usage patterns on which the virtual item / service
consumption revenue recognition model is based. We continually monitor the operational statistics and usage patterns.
Online game services over third party platform
Certain social games, TV games, certain web games and certain MMOGS, have adopted the virtual item / service
consumption model, and are launched on the third party game platforms and telecom carriers. Revenue from social and web games
operated through third party game platforms are recognized upon consumption of the in-game premium features with the amount net
of remittance to the third party game platforms as we do not set the pricing of the in-game currency of the third party game platforms.
Revenue from TV games operated through telecom carriers and certain MMOGS operated on the third party game
platforms are recognized upon consumption of the in-game premium features based on the gross amount paid, as we are the primary
obligor of the games operation. The remittance to the telecom carrier and third party game platforms is recognized as costs of revenue
when incurred.
Licensing revenue
We license our proprietary online games to other game operators and receive license fees and royalty income in connection
with their operation of the games. License fee revenue is recognized over the license period upon the commercialization of the game
in the overseas market. Royalty income is recognized when earned, provided that collectability is reasonably assured.
Other Revenues
Other revenues include those generated from training and advertising services.
Training and advertisement
Training and advertisement revenue include revenues generated from providing technical training to college students on
mobile application programming and, prior to the sale of our 58% equity interest in our mobile advertising platform, advertising
services on our mobile advertising platform. These revenues are recognized when delivery of the website advertisement has occurred
or when services have been rendered and the collection of the related fees is reasonably assured.
Income Taxes
We account for income taxes under the asset and liability method. Deferred taxes are determined based upon the
differences between the carrying value of assets and liabilities for financial reporting and tax purposes at currently enacted statutory
tax rates for the years in which the differences are expected to reverse. The effect on deferred taxes of a change in tax rates is
recognized in income in the period of change.
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A valuation allowance is provided on deferred tax assets to the extent that it is more likely than not that such deferred tax
assets will not be realized. The total income tax provision includes current tax expenses under applicable tax regulations and the
change in the balance of deferred tax assets and liabilities. Realization of the future tax benefits related to the deferred tax assets is
dependent on many factors, including our ability to generate taxable income within the period during which the temporary differences
reverse or our tax loss carry forwards expire, the outlook for the PRC economic environment, and the overall future industry outlook.
We consider these factors in reaching our conclusion on the recoverability of the deferred tax assets and determine the valuation
allowances necessary at each balance sheet date.
We recognize the impact of an uncertain income tax position at the largest amount that is more-likely-than-not to be
sustained upon audit by the relevant tax authority. Income tax related interest is classified as interest expenses and penalties as
income tax expense. As of December 31, 2013, 2014 and 2015, we did not have any material liability for uncertain tax positions. Our
policy is to recognize, if any, tax-related interest as interest expenses and penalties as income tax expenses. For the years ended
December 31, 2013, 2014 and 2015, we did not have any material interest and penalties associated with tax positions.
Intangible Assets
Our intangible assets consist primarily of acquired game licenses and acquired game development costs from business
combination.
Acquired game licenses are amortized on a straight-line basis over the shorter of the useful economic life of the relevant
online game or license period, which range from two to seven years. Amortization of upfront licensing fees commences upon the
monetization of the related online game. We recognize intangible assets acquired through business acquisitions as assets separate
from goodwill. Acquired in-process research and development costs are initially considered an indefinite-lived asset. Subsequently,
they are recorded as acquired game development cost upon completion of the research and development efforts and are amortized on
a straight-line basis over the useful economic life of the relevant online game. Amortization of acquired game development cost
commences upon the monetization of the related online game.
Goodwill
Goodwill represents the excess of the purchase price over the fair value of the identifiable assets and liabilities acquired as
a result of an acquisition we make. Goodwill is not amortized, but tested for impairment annually, or more frequently if events or
changes in circumstances indicate that it might be impaired. In December of each year, we test impairment of goodwill at the
reporting unit level and recognize impairment in the event that the carrying value exceeds the fair value of each reporting unit.
Goodwill impairment assessment requires significant judgment, including assumptions used to determine the fair value of the
reporting units. We determine the fair value of our reporting units based on the present value of estimated future cash flows of the
reporting units. If the carrying amount is in excess of the fair value, step two requires the comparison of the implied fair value of the
reporting unit’s goodwill with the carrying amount of the reporting unit’s goodwill. Any excess of the carrying value of the reporting
unit’s goodwill over the implied fair value of the reporting unit’s goodwill is recorded as an impairment loss. After completing our
annual impairment reviews during the fourth quarter of 2013, 2014 and 2015, the reporting unit that was subject to the annual
impairment testing had a fair value which exceeded its respective carrying value by a significant margin with no risk of failing the
first step of the impairment test. We concluded that goodwill was not impaired as of December 31, 2013, 2014 and 2015.
Share-Based Compensation
Under our Option Plan, we granted a total of 355,000 and 10,110,000 options to our employees and directors in 2013 and
2015, respectively. We did not grant any options under the Option Plan in 2014.
We measure the cost of employee services received in exchange for stock-based compensation measured at the grant date
fair value of the award. For the awards that are modified, we determine the incremental cost as the excess of the fair value of the
modified award over the fair value of the original award immediately before its terms are modified, measured based on the share price
and other pertinent factors at that date. We recognize the compensation costs, net of the estimated forfeiture, on a straight-line basis
over the vesting period of the award, which generally ranges from one to four years. Forfeiture rates are estimated based on historical
forfeiture patterns and adjusted to reflect future changes in circumstances and facts, if any. If actual forfeitures differ from those
estimates, the estimates may be revised in subsequent periods. We use historical data to estimate pre-vesting option forfeitures and
record stock-based compensation expense only for those awards that are expected to vest.
55
Determining the fair value of stock options requires significant judgment. We measure the fair value of the stock options
using the Black-Scholes option-pricing model with assumptions made regarding expected term, volatility, risk-free interest rate, and
dividend yield. The expected term represents the period of time that the awards granted are expected to be outstanding. The expected
term is determined based on historical data on employee exercise and post-vesting employment termination behavior, or the
“simplified” method for stock option awards with the characteristics of “plain vanilla” options for 2010 and 2011. Expected
volatilities are based on historical volatilities of our ordinary shares. Risk-free interest rate is based on U.S. government bonds issued
with maturity terms similar to the expected term of the stock-based awards. While we paid a discretionary cash dividend in January
2009, we do not anticipate paying any recurring cash dividends in the foreseeable future.
In addition, on December 8, 2010, we granted 1,500,000 ordinary shares to Jun Zhu, our chairman and chief executive
officer, which will only be vested if our company achieves certain income targets and the shares are not entitled to receive dividends
until they become vested. Of such shares, 500,000 ordinary shares were vested and issued to Incsight Limited, a company wholly
owned by Jun Zhu, on November 17, 2015. We considered the grant of ordinary shares as an incentive to retain Mr. Jun Zhu’s
services with our company. The awarded non-vested shares would be valid for five years from December 8, 2010. The fair value of
the granted non-vested shares is US$6.48 per share, the market price on the date of grant. We record share-based compensation
expenses for these performance-based awards based upon our estimate of the probable outcome at the end of the performance period
(i.e., the estimated performance against the performance targets). We periodically adjust the cumulative share-based compensation
recorded when the probable outcome for these performance-based awards is updated based upon changes in actual and forecasted
operating results. Our actual performance against the performance targets could differ materially from our estimates.
In May 2011, we granted 30,000 ordinary shares to each of our four non-executive directors, of which 10,000 ordinary
shares vest for each director on July 1 of each year from 2011 to 2013 so long as such director continues his service as of such date.
An aggregate of 40,000 ordinary shares vested in each of July 2011, July 2012 and July 2013, respectively. The fair value of the
shares granted was US$6.03 per share, being the market price on the date of the grant.
In February 2006, Red 5 adopted a Stock Incentive Plan, or Red 5 Stock Incentive Plan, under which Red 5 may grant to
its employees, director and consultants stock options to purchase common stocks or restricted stocks of Red 5. Red 5 granted options
to purchase an aggregate of 28,963,258 shares of common stock under the Red 5 Stock Incentive Plan from April 6, 2010 to
December 31, 2013. In September 2012, Red 5 granted an aggregate of 6,122,435 restricted common stocks to two directors of Red 5
including Mr. Zhu for their services to Red 5. We measure the share-based compensation based on the fair value of the award as of
the grant date. We measure the fair value of the stock options using the Black-Scholes option-pricing model with assumptions made
regarding the fair value of the common stock, expected term, volatility, risk-free interest rate, and dividend yield.
Share-based compensation expenses of RMB29.2 million, RMB3.7 million and RMB34.0 million (US$5.2 million) were
recognized for the years ended December 31, 2013, 2014 and 2015, respectively, for options and warrants granted to our company’s
and its subsidiaries’ employees and directors, including incremental compensation cost due to the modification of option exercise
price in April 2013 and November 2015.
Impairment Loss of Equity Investment
We assess our equity investments for impairment on a periodic basis by considering factors including, but not limited to,
current economic and market conditions, the operating performance of the investees including current earnings trends, the
technological feasibility of the investee’s products and technologies, the general market conditions in the investee’s industry or
geographic area, factors related to the investee’s ability to remain in business, such as the investee’s liquidity, debt ratios, and cash
burn rate and other company-specific information including recent financing rounds. If it has been determined that the carrying
amount of equity investment are higher than related fair value and that this decline is other-than-temporary, the carrying value of the
equity investment is adjusted downward to reflect these declines in value. Impairment loss relating to investment in an equity investee
of RMB41.7 million, nil and nil was recognized in 2013, 2014 and 2015, respectively.
56
Impairment on Long-lived Assets and Allowance on Long-term Receivable
We review long-lived assets and intangible assets for impairment whenever events or changes in circumstances indicate
that the carrying amount of an asset or asset group may not be recoverable. We assess the recoverability of long-lived assets and
intangible assets (other than goodwill) by comparing the carrying amount to the estimated future undiscounted cash flow associated
with the related assets. We recognize impairment of long-lived assets and intangible assets in the event that the net book value of such
assets exceeds the estimated future undiscounted cash flow attributable to such assets. We use estimates and judgment in our
impairment tests, and if different estimates or judgments had been utilized, the timing or the amount of the impairment charges could
be different. Impairment charges relating to equipment amounting to RMB1.9 million, nil and nil were recognized in 2013, 2014 and
2015, respectively. Impairment charges relating to intangible assets and other assets amounting to RMB3.8 million, RMB3.6 million
and RMB8.4 million (US$1.3 million) were recognized in 2013, 2014 and 2015, respectively. Impairment charges relating to other
long-lived assets amounting to RMB11.8 million, nil and nil were recognized in 2013, 2014 and 2015, respectively. We determine the
allowances on long-term receivables when facts and circumstances indicate that the long-term receivable is unlikely to be collected.
When the collectability of the long-term receivable became likely subsequently, we reverse the allowance. We provided allowance on
long-term receivables amounting to RMB17.9 million in 2013 while in 2014 we reversed the allowance on long-term receivables
amounting to RMB17.9 million.
Refund of WoW Game Points
As a result of non-renewal of WoW license on June 7, 2009, we announced a refund plan in connection with unactivated
WoW game point cards. According to the plan, unactivated WoW game point card holders are eligible to receive a cash refund from
us. We recorded a liability in connection with both unactivated points cards and activated but unconsumed point cards of
approximately RMB200.4 million, of which RMB4.0 million was refunded in 2009. Upon the loss of the WoW license, we concluded
that the nature of the obligation substantively changed from deferred revenue, for which we had the ability to satisfy the underlying
performance obligation, to an obligation to refund players for their unconsumed points. Thus, we have accounted for this refund
liability by applying the relevant derecognition guidance when determining the proper accounting treatment. In accordance with this
guidance, the refund liability associated with these WoW game points, to the extent not refunded, will be recorded as other operating
income after we are legally released from the obligation to refund amounts under the applicable laws. As we announced the refund
plan on September 7, 2009, the statute of limitations of the creditors (in this case the game players with claims for refund of
unactivated WoW game point cards) to assert their claims for refund is two years from such date under applicable laws and thus our
legal liability relating to the unactivated WoW game point cards was extinguished on September 7, 2011 and the associated liability
amounting to RMB26.0 million was recognized as other operating income for the year ended December 31, 2011. With respect to the
remaining refund liability, based on current PRC laws, to the extent not refunded, we, in consultation with legal counsel, have
determined that we will be legally released from this liability in 2029, which represents 20 years from the date of discontinuation of
WoW in 2009. However, if management were to publicly announce a refund policy, we would be legally released from any
remaining liability for these activated, but unconsumed points, sooner than 20 years. To date, we have determined not to publicly
announce any refund policy with respect to this remaining liability, and no refunds have been claimed. The remaining refund liability
relating to the activated, but unconsumed WoW game points was RMB170.0 million (US$26.2 million) as of December 31, 2015.
Convertible Notes and Beneficial Conversion Feature (“BCF”)
We have issued convertible notes and warrants in December 2015. We have evaluated whether the conversion feature of
the notes is considered an embedded derivative instrument subject to bifurcation in accordance with ASC 815, Accounting for
Derivative Instruments and Hedging Activities. Based on our evaluation, the conversion feature is not considered an embedded
derivative instrument subject to bifurcation as conversion option does not provide the holder of the notes with means to net settle the
contracts. Convertible notes, for which the embedded conversion feature does not qualify for derivative treatment, are evaluated to
determine if the effective rate of conversion pursuant to the terms of the convertible note agreement is below market value. In these
instances, the value of the BCF is determined as the intrinsic value of the conversion feature, which is recorded as deduction to the
carrying amount of the notes and credited to additional paid-in-capital. For convertible notes issued with detachable warrants, a
portion of the note’s proceeds is allocated to the warrant based on the fair value of the warrants as of the date of issuance. The
allocated fair values for the warrants and BCF are both recorded in the financial statements as debt discounts from the face amount of
the notes, which are then accreted to interest expense over the life of the related debt using the effective interest method.
57
Warrants
We account for the detachable warrants issued in connection with convertible notes under the authoritative guidance on
accounting for derivative financial instruments indexed to, and potentially settled in, a company’s own stock. We classify warrants in
our consolidated balance sheet as a liability which is revalued at each balance sheet date subsequent to the initial issuance. We use the
Black-Scholes pricing model to value the warrants. Determining the appropriate fair-value model and calculating the fair value of
warrants requires considerable judgment. A small change in the estimates used may cause a relatively large change in the estimated
valuation. The estimated volatility of our common stock at the date of issuance, and at each subsequent reporting period, is based on
historic fluctuations in our stock price. The risk-free interest rate is based on U.S. government bonds with a maturity similar to the
expected remaining life of the warrants at the valuation date. The expected life of the warrants is based on the historical pattern of
exercises of warrants.
Redeemable Non-controlling Interests
Redeemable non-controlling interests are equity interests of our consolidated subsidiary not attribute to us that have
redemption features that are not solely within our control. These interests are classified as temporary equity because their redemption
is considered probable. These interests are measured at the greater of estimated redemption value at the end of each reporting period
or the initial carrying amount of the redeemable non-controlling interests adjusted for cumulative earning allocations.
Recent Accounting Pronouncements
In May 2014, the Financial Accounting Standards Board (FASB) issued an accounting standard update on revenue
recognition that will be applied to all contracts with customers. The update requires an entity to recognize revenue when it transfers
promised goods or services to customers in an amount that reflects what it expects in exchange for the goods or services. It also
requires more detailed disclosures to enable users of financial statements to understand the nature, amount, timing and uncertainty of
revenue and cash flows arising from contracts with customers. In August 2015, the FASB issued ASU No. 2015-14, deferring the
effective date for ASU 2014-09 by one year, and thus, the new standard will be effective for fiscal years beginning after December
15, 2017, with early application permitted only as of annual reporting periods beginning after December 15, 2016, including interim
reporting periods within that reporting period. The guidance allows for either a full retrospective or a modified retrospective transition
method. We are currently assessing the impact that the guidance will have on our financial condition and results of operations.
In February 2015, the FASB issued ASU 2015-02 to respond to stakeholders’ concerns about the current accounting for
consolidation of certain legal entities. Stakeholders expressed concerns that current generally accepted accounting principles (GAAP)
might require a reporting entity to consolidate another legal entity in situations in which the reporting entity’s contractual rights do
not give it the ability to act primarily on its own behalf, the reporting entity does not hold a majority of the legal entity’s voting rights,
or the reporting entity is not exposed to a majority of the legal entity’s economic benefits or obligations. Financial statement users
asserted that in certain of those situations in which consolidation is ultimately required, deconsolidated financial statements are
necessary to better analyze the reporting entity’s economic and operational results. Previously, the FASB issued an indefinite deferral
for certain entities to partially address those concerns. However, the amendments in this update rescind that deferral and address those
concerns by making changes to the consolidation guidance. The ASU is effective for fiscal years beginning after December 15, 2016,
and interim periods thereafter. Early adoption is permitted. We are in the process of evaluating the impact of the standard on our
consolidated financial statements.
58
In April 2015, the FASB issued ASU 2015-03 to simplify presentation of debt issuance costs, which requires that debt issuance
costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt
liability, consistent with debt discounts. The recognition and measurement guidance for debt issuance costs are not affected by the
amendments. The ASU is effective for fiscal years beginning after December 15, 2016, and interim periods thereafter. Early adoption is
permitted. We have adopted this guidance as of December 31, 2015. The adoption of this guidance did not have a material effect on our
financial condition, results of operations and cash flows.
In May 2015, the FASB issued ASU 2015-07, Topic 820, and Fair Value Measurement, which permits a reporting entity, as a
practical expedient, to measure the fair value of certain investments using the net asset value per share of the investment. Currently,
investments valued using the practical expedient are categorized within the fair value hierarchy on the basis of whether the investment is
redeemable with the investee at net asset value on the measurement date, never redeemable with the investee at net asset value, or
redeemable with the investee at net asset value at a future date. For investments that are redeemable with the investee at a future date, a
reporting entity must take into account the length of time until those investments become redeemable to determine the classification within
the fair value hierarchy.
In November 2015, the FASB issued ASU 2015-17 to simplify the presentation of deferred income taxes, which requires that
deferred tax liabilities and assets be classified as noncurrent in a classified statement of financial position. The amendments in this update
apply to all entities that present a classified statement of financial position. The current requirement that deferred tax liabilities and assets of
a tax-paying component of an entity be offset and presented as a single amount is not affected by the amendments in this update. We have
adopted this guidance during the year ended December 31, 2015 with a retroactive application. The adoption of this guidance did not have a
material effect on our financial condition, results of operations and cash flows.
In January 2016, the FASB issued ASU 2016-01 to improve and to achieve convergence of their respective standards on the
accounting for financial instruments and enhance the reporting model for financial instruments to provide users of financial statements with
more decision-useful information. The amendments in this update address certain aspects of recognition, measurement, presentation, and
disclosure of financial instruments. The FASB board is also addressing measurement of credit losses on financial assets in a separate project.
For public business entities, the amendments in this update are effective for fiscal years beginning after December 15, 2017, including
interim periods within those fiscal years. The adoption of this guidance did not have a material effect on our financial condition, results of
operations and cash flows.
In February 2016, the FASB issued ASU 2016-02 to increase transparency and comparability among organizations by
recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements. The ASU is
effective for fiscal years beginning after December 15, 2016, and interim periods thereafter. Early adoption is permitted. We are in the
process of evaluating the impact of the standard on its consolidated financial statements.
In March 2016, the FASB issued ASU 2016-06, which clarifies the requirements for assessing whether contingent call (put)
options that can accelerate the payment of principal on debt instruments are clearly and closely related to their debt hosts. An entity
performing the assessment under the amendments in this update is required to assess the embedded call (put) options solely in accordance
with the four-step decision sequence. For public business entities, the amendments in this update are effective for financial statements issued
for fiscal years beginning after December 15, 2016, and interim periods within those fiscal years. An entity should apply the amendments in
this update on a modified retrospective basis to existing debt instruments as of the beginning of the fiscal year for which the amendments are
effective. Early adoption is permitted, including adoption in an interim period. If an entity early adopts the amendments in an interim period,
any adjustments should be reflected as of the beginning of the fiscal year that includes that interim period. We are in the process of
evaluating the impact of adoption of this guidance on our consolidated financial statements.
In March 2016, the FASB issued ASU 2016-07, which eliminates the requirement to retroactively adopt the equity method of
accounting. The amendments require that the equity method investor adds the cost of acquiring the additional interest in the investee to the
current basis of the investor’s previously held interest and adopt the equity method of accounting as of the date the investment becomes
qualified for equity method accounting. The amendments in this update are effective for all entities for fiscal years, and interim periods
within those fiscal years, beginning after December 15, 2016. The amendments should be applied prospectively upon their effective date to
increases in the level of ownership interest or degree of influence that result in the adoption of the equity method. Early application is
permitted. We are in the process of evaluating the impact of adoption of this guidance on our consolidated financial statements.
In March 2016, the FASB issued ASU 2016-09, which simplifies several aspects of the accounting for employee share-based
payment transactions for both public and non-public entities, including the accounting for income taxes, forfeitures, and statutory tax
withholding requirements, as well as classification in the statement of cash flows. For public entities, the ASU is effective for annual
reporting periods beginning after December 15, 2016, including interim periods within those annual reporting periods. Early adoption will be
permitted in any interim or annual period for which financial statements have not yet been issued or have not been made available for
issuance. We are in the process of evaluating the impact of adoption of this guidance on our consolidated financial statements.
59
Results of Operations
The following table sets forth a summary of our consolidated statements of operations for the periods indicated.
Consolidated Statement of Operation Data
Revenues:
Online game services
Other revenues
Sales taxes
Net revenues
Cost of revenue
Gross profit (loss)
Operating expenses:
Product development
Sales and marketing
General and administrative
(Provision) reversal of provision for allowance for long-term
receivable and prepayment
Impairment of long-lived assets
Gain on disposal of subsidiaries
Total operating expenses
Other operating income (expenses)
Loss from operations
Impairment on investments
Interest income
Interest expenses
Fair value change on convertible bonds and warrants
Gain on disposal of equity investee and available-for-sale investment
Other income (expenses), net
Loss before income tax expense and share of loss in equity method
investments
Share of loss in equity investments
Net loss
Net loss attributable to noncontrolling interest
Net loss attributable to redeemable noncontrolling interest
Net loss attributable to The9 Limited
Accretion on redeemable noncontrolling interest
Net loss attributable to holders of ordinary shares
For the Year Ended December 31,
2013
RMB
2014
RMB
2015
RMB
US$(1)
95,131,347 55,417,700 40,504,363 6,252,797
942,530
11,495,630
(30,652)
(1,850,908)
104,776,069 64,276,891 46,411,331 7,164,675
(107,803,360) (85,782,569) (67,743,995) (10,457,871)
(3,027,291) (21,505,678) (21,332,664) (3,293,196)
9,421,865 6,105,523
(198,555)
(562,674)
For the Year Ended December 31,
2013
RMB
2014
RMB
2015
RMB
US$(1)
(213,243,567)
(116,672,411)
(161,958,423)
(156,253,036) (135,042,829) (20,847,020)
(51,758,100) (31,692,522) (4,892,482)
(111,157,250) (131,768,503) (20,341,552)
(29,741,076)
(5,725,046)
—
(527,340,523)
120,000
(530,247,814)
(47,970,885)
8,376,355
—
—
—
9,301,565
75,000
(1,563,518)
—
3,339,394
(8,439,580) (1,302,847)
14,371,918
—
—
165,392,382
515,514
(139,404,086) (303,604,040) (46,868,387)
(241,366)
(160,834,764) (326,500,222) (50,402,949)
—
—
119,663
775,152
(6,397,192)
(987,556)
(7,129,161) (1,100,553)
—
(295,896)
—
3,414,559
—
—
33,153,452
(963,125)
—
(1,916,755)
(560,540,779)
(2,375,826)
(562,916,605)
(36,655,033)
—
(526,261,572)
—
(526,261,572)
(125,229,878) (341,168,178) (52,667,291)
(3,712,530) (13,013,791) (2,008,983)
(128,942,408) (354,181,969) (54,676,274)
(21,443,321) (16,655,902) (2,571,228)
(20,876,617) (32,697,713) (5,047,657)
(86,622,470) (304,828,354) (47,057,389)
21,076,744 79,805,706 12,319,878
(107,699,214) (384,634,060) (59,377,267)
(1) Translation from RMB amounts into U.S. dollars was made at a rate of RMB6.4778 to US$1.00 for the convenience of the reader
only. See “Item 3. Key Information—A. Selected Financial Information—Exchange Rate Information.”
Year 2015 Compared to Year 2014
Revenues. Our revenues decreased by 28.1%, from RMB64.8 million in 2014 to RMB46.6 million (US$7.2 million) in 2015,
primarily due to a decrease in revenue from our online game services.
Online Game Services. Our revenues from our online game services decreased by 26.9%, from RMB55.4 million in 2014 to
RMB40.5 million (US$6.3 million) in 2015. The decrease was primarily due to a decrease in revenues from PC online games which
decreased from RMB33.4 million in 2014 to RMB16.1 million (US$2.5 million) in 2015. Such decrease was primarily due to the net
effect of (i) the decrease of our average quarterly paying user from 42,620 in 2014 to 10,364 in 2015, and (ii) the increase of our average
quarterly revenue per paying user from RMB254 in 2014 to RMB369 (US$56.9) in 2015.
60
The number of quarterly active users refers to the number of users who log into our games at least once during a quarter.
The number of average quarterly active users is the average of quarterly active users for each of the four quarters during a year.
Quarterly paying user refers to the number of users who purchase virtual currency at least once for our online games during a quarter.
Average quarterly paying user is the average of quarterly paying users for each of the four quarters during a year. Quarterly revenue
per paying user refers to our revenues from online games during a given quarter divided by the number of the quarterly paying users.
Average quarterly revenue per paying user is the average of quarterly revenues per paying users for each of the four quarters during a
year.
Our revenues from TV games increased from RMB19.2 million in 2014 to RMB22.8 million (US$3.5 million) in 2015.
This increase was primarily due to an increase in our average quarterly revenue per paying user from RMB37 in 2014 to RMB49
(US$7.4) in 2015. Unlike PC online games, our TV games are operated through telecommunication carriers and we do not maintain
information relating to active users pursuant to our cooperation agreements with the telecom carriers.
The average quarterly revenue per paying user of our PC online games is significantly higher than that of our TV games
because the PC online game players are mostly teenagers with higher spending power while the TV game players are mostly children
and elderly people with lower spending power.
Other Revenues. Revenues generated from other products and services decreased by 35.2% from RMB9.4 million in 2014
to RMB6.1 million (US$0.9 million) in 2015, primarily due to a decrease in revenue from our mobile advertising platform. We
disposed of 58% equity interest in Shanghai Jiucheng Advertising, which operates our mobile advertising platform, in October 2015.
We account for Shanghai Jiucheng Advertisement as an equity investment after such disposal.
Cost of Revenue. Cost of revenue decreased by 21.0% from RMB85.8 million in 2014 to RMB67.7 million (US$10.5
million) in 2015. The decrease was primarily driven by a decrease of the rental cost in connection with the Internet data centers,
which is in line with revenue decrease, and a decrease in employee salary and welfares as we continued to reduce the headcounts in
our customer service department in 2015 as part of our cost saving efforts.
Operating Expenses. Operating expenses increased by 117.8% from RMB139.4 million in 2014 to RMB303.6 million
(US$46.9 million) in 2015.
Product Development Expenses. Product development expenses decreased by 13.6% from RMB156.3 million in 2014 to
RMB135.0 million (US$20.8 million) in 2015. The decrease was primarily due to the decrease of research and development staff cost
and development outsourcing expenses due to less volume of outsourced development works.
Sales and Marketing Expenses. Sales and marketing expenses decreased by 38.8% from RMB51.8 million in 2014 to
RMB31.7 million (US$4.9 million) in 2015. The decrease in sales and marketing expenses was primarily due to decreased expenses
incurred for Firefall in North America and Europe in 2015.
General and Administrative Expenses. General and administrative expenses increased by 18.5% from RMB111.2 million
in 2014 to RMB131.8 million (US$20.3 million) in 2015.
(Provision) reversal of provision for allowance for long-term receivables and prepayments. We recorded allowance of
other receivable of RMB8.4 million (US$1.3 million) in 2015. In 2014, we had allowance for long-term receivables and prepayments
charges of RMB3.6 million, and we reversed an allowance on long-term receivables of RMB17.9 million in 2014 as we reevaluated
the collectability of the receivables and determined that the payments can be collected. We collected the amount in full in 2015.
Gain/loss on Disposal of Subsidiaries. We recorded a gain on disposal of a subsidiary of RMB3.3 million (US$0.5 million)
in October 2015 in connection with the disposal of 58% equity interest in Shanghai Jiucheng Advertisement, which operates our
mobile advertising platform. We recorded a gain on disposal of subsidiaries of RMB165.4 million in 2014 in connection with
disposal of our equity interests in Huopu Cloud and Kai Yue.
Other Operating Income (Expenses). We recorded rental income of RMB75,000 and loss on disposal of property,
equipment and software of RMB1.6 million (US$0.2 million) in 2014 and 2015, respectively.
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Interest Income. We had interest income of RMB0.8 million (US$0.1 million) in 2015, compared to net interest income of
RMB3.4 million in 2014, primarily due to the decrease in cash balance during the year of 2015.
Interest Expenses. We had interest expenses of RMB6.4 million (US$1.0 million) in 2015, compared to nil in 2014,
primarily due to the accrual of interest expenses of RMB5.9 million (US$0.9 million) in connection with the Convertible Notes issued
in December 2015 and RMB0.5 million (US$0.08 million) in connection with loans in 2015.
Fair Value of Change on Convertible Bonds and Warrants. We had fair value of change on convertible bonds and
warrants of RMB7.1 million (US$1.1 million) in 2015 primarily due to a decrease in our share price as of December 31, 2015
compared to the issuance date of the Convertible Notes and the Warrants.
Other Income (Expenses), Net. Other expenses were RMB1.9 million (US$0.3 million) in 2015, which mainly reflected
exchange loss. Other expenses were RMB1.0 million in 2014, which mainly reflected exchange loss, partially offset by the
government subsidy we received.
Gain on Disposal of Equity Investee and Available-for-Sale Investment. We recorded a gain on disposal of equity
investee and available-for-sale investment of RMB33.2 million in 2014 in connection with the disposal of Beijing Linkage, Tandem
Fund II, L.P., or Tandem Fund, and Youjia Group Limited, or Youjia. We did not have any such gain or loss in 2015.
Net Loss Attributable to Holders of Ordinary Shares. As a result of the cumulative effect of the above factors, net loss
attributable to our holders of ordinary shares was RMB384.6 million (US$59.4 million) in 2015, compared to the net loss of
RMB107.7 million in 2014.
Year 2014 Compared to Year 2013
Revenues. Our revenues decreased by 39.2%, from RMB106.6 million in 2013 to RMB64.8 million in 2014, primarily due
to a decrease in revenue from our online game services.
Online Game Services. Our revenues from our online game services decreased by 41.7%, from RMB95.1 million in 2013
to RMB55.4 million in 2014. The decrease was primarily due to a decrease in revenues from PC online games, including web games
Winning Goal and Winning Dunk, and MMO games Planetside 2 and SUN, which decreased from RMB67.1 million in 2013 to
RMB33.5 million in 2014. Such decrease was primarily due to the net effect of (i) the increase of our average quarterly revenue per
paying user from RMB228 in 2013 to RMB254 in 2014, and (ii) the decrease in average quarterly paying users which was in line
with the decrease in average quarterly active users from 2,095,890 in 2013 to 983,805 in 2014.
The number of quarterly active users refers to the number of users who log into our games at least once during a quarter.
The number of average quarterly active users is the average of quarterly active users for each of the four quarters during a year.
Quarterly paying user refers to the number of users who purchase virtual currency at least once for our online games during a quarter.
Average quarterly paying user is the average of quarterly paying users for each of the four quarters during a year. Quarterly revenue
per paying user refers to our revenues from online games during a given quarter divided by the number of the quarterly paying users.
Average quarterly revenue per paying user is the average of quarterly revenues per paying users for each of the four quarters during a
year.
Our revenues from TV games decreased from RMB21.6 million in 2013 to RMB19.2 million in 2014. This decrease was
primarily due to a decrease in the number of average quarterly paying users from 211,880 in 2013 to 132,116 in 2014, partially offset
by an increase in our average quarterly revenue per paying user from RMB25 in 2013 to RMB37. Unlike PC online games, our TV
games are operated through telecommunication carriers and we do not maintain information relating to active users pursuant to our
cooperation agreements with the telecom carriers.
The average quarterly revenue per paying user of our PC online games is significantly higher than that of our TV games
because the PC online game players are mostly teenagers with higher spending power while the TV game players are mostly children
and elderly people with lower spending power.
62
Other Revenues. Revenues generated from other products and services decreased by 18.0% from RMB11.5 million in 2013
to RMB9.4 million in 2014. The decrease is mainly due to a decrease in revenue from our mobile advertising platform caused by
intense market competition.
Cost of Revenue. Cost of revenue decreased by 20.4% from RMB107.8 million in 2013 to RMB85.8 million in 2014. The
decrease was primarily driven by a decrease of the rental cost in connection with the Internet data centers, which is in line with
revenue decrease, and a decrease in employee salary and welfares as we continued to reduce the headcounts in our customer service
department in 2014 as part of our cost saving efforts. In addition, while we recorded impairment cost of royalty fee for Planetside 2
due to the lower-than-expected revenue generated in 2013.
Operating Expenses. Operating expenses decreased by 73.6% from RMB527.3 million in 2013 to RMB139.4 million in
2014.
Product Development Expenses. Product development expenses decreased by 26.7% from RMB213.2 million in 2013 to
RMB156.3 million in 2014. The decrease was primarily due to the decrease of research and development staff cost and development
outsourcing expenses due to less volume of outsourced development works.
Sales and Marketing Expenses. Sales and marketing expenses decreased by 55.6% from RMB116.7 million in 2013 to
RMB51.8 million in 2014. The decrease in sales and marketing expenses primarily reflected less expenses incurred for launching
Firefall in North America and Europe in 2014 compared to those incurred for launching Planetside 2 in 2013.
General and Administrative Expenses. General and administrative expenses decreased by 31.4% from RMB162.0 million
in 2013 to RMB111.2 million in 2014, primarily due to a decrease in share based compensation and professional services fees.
Impairment on Long-lived Assets. Impairment charges relate to the impairment on certain equipment and intangible assets
amounting to RMB5.7 million and nil for the years ended December 31, 2013 and 2014, respectively.
(Provision) reversal of provision for allowance for long-term receivables and prepayments. We recorded allowance for
long-term receivables and prepayments amounting to RMB29.7 million in 2013. In 2014, we had allowance for long-term receivables
and prepayments charges of RMB3.6 million, and we reversed an allowance on long-term receivables of RMB17.9 million in 2014 as
we reevaluated the collectability of the receivables and determined that the payments can be collected. We collected the amount in
full in 2015.
Gain on Disposal of Subsidiaries. We recorded a gain on disposal of subsidiaries of RMB165.4 million in 2014 in
connection with the disposal of our equity interests in Huopu Cloud and Kai Yue. We did not record any gain on disposal of
subsidiaries in 2013.
Other Operating Income. We recorded rental income of RMB120,000 and RMB75,000 in 2013 and 2014, respectively, as
other operating income.
Impairment on Available-for-Sale Investment. In 2014, we did not incur any impairment loss on available-for-sale
investment. We had RMB6.3 million of impairment loss on available-for-sale investment in 2013.
Investment Income from Cost Method Investment. Our investment income from cost method investment was RMB1.1
million in 2014. We did not have investment income from cost method investment in 2013.
Interest Income, Net. Net interest income decreased by 59.2% from RMB8.4 million in 2013 to RMB3.4 million in 2014,
mainly due to the decrease in cash balance during the first half year of 2014.
Other Income (Expenses), Net. Other expenses were RMB1.0 million in 2014, which mainly reflected exchange loss,
partially offset by the government subsidy we received. Other income was RMB9.3 million in 2013, which mainly reflected a refund
of game license fee, exchange gains and a government subsidy.
63
Gain on Disposal of Equity Investee and Available-for-Sale Investment. We recorded a gain on disposal of equity
investee and available-for-sale investment of RMB33.2 million in 2014 in connection with the disposal of Beijing Linkage, Tandem
Fund and Youjia. We did not record any gain on investment disposal in 2013.
Impairment Loss on Investments. In 2014, we did not incur any impairment loss on investment. We had RMB41.7 million
of impairment loss on investment in 2013 in connection with our investments in several early-stage mobile game and application
development companies in the United States and China.
Net Loss Attributable to Holders of Ordinary Shares. As a result of the cumulative effect of the above factors, net loss
attributable to our holders of ordinary shares was RMB107.7 million in 2014, compared to the net loss of RMB526.3 million in 2013.
B. Liquidity and Capital Resources
We are a holding company and conduct our operations primarily through our subsidiaries and affiliated PRC entities in
China. As a result, our cash requirements and our ability to pay dividends principally depend upon dividends and other distributions
from our subsidiaries, which in turn are derived principally from earnings generated by our affiliated PRC entities. Specifically, The9
Computer (one of our subsidiaries in China) obtains funds from the PRC entities in the form of payments under the exclusive
technical service agreements, pursuant to which The9 Computer is entitled to determine the amount of payment.
We acknowledge that the PRC government imposes controls on the convertibility of the RMB into foreign currencies, and
in certain cases, the remittance of currency out of China. However, under existing PRC foreign exchange regulations, payments of
current account items, including profit distributions and trade and service-related foreign exchange transactions, can be made in
foreign currencies without prior approval from SAFE, by complying with certain procedural requirements. Therefore, we are able to
pay dividends in foreign currencies without prior approval from SAFE. Approval from or registration with appropriate government
authorities is required where RMB is to be converted into foreign currency and remitted out of China to pay capital expenses such as
the repayment of loans denominated in foreign currencies.
Furthermore, if our subsidiaries or any newly formed subsidiaries incur debt on their own behalf, the agreements governing
their debt may restrict their ability to pay dividends to us. See “Item 3. Key Information —D. Risk Factors—Risks Related to Doing
Business in China—Restrictions on currency exchange in China limit our ability to utilize our revenues effectively, make dividend
payments and meet our foreign currency denominated obligations.”
Current PRC regulations restrict our affiliated entities and subsidiaries from paying dividends in the following two
principal aspects: (i) our affiliated entities and subsidiaries in China are only permitted to pay dividends out of their respective
accumulated profits, if any, determined in accordance with PRC accounting standards and regulations; and (ii) these entities are
required to allocate at least 10% of their respective accumulated profits each year, if any, to fund certain capital reserves until the
cumulative total of the allocated reserves reaches 50% of registered capital, and a portion of their respective after-tax profits to their
staff welfare and bonus reserve funds as determined by their respective boards of directors. Although the statutory reserves can be
used, among other ways, to increase the registered capital and eliminate future losses in excess of retained earnings of the respective
companies, companies may not distribute the reserve funds as cash dividends except upon a liquidation of these subsidiaries. In
addition, dividend payments from our PRC subsidiaries could be delayed as we may only distribute such dividends upon completion
of annual statutory audits of the subsidiaries. As of December 31, 2015, such restricted portion was RMB23.3 million
(US$3.6 million). We have not directed our PRC subsidiaries or affiliated entities to distribute any dividends to-date.
The aggregate net assets as of December 31, 2013, 2014 and 2015, as reflected on our statutory accounts, including
registered capital and statutory reserves, was approximately RMB67.0 million and RMB75.6 million and RMB97.9 million (US$15.1
million) lower than the amount determined under U.S. GAAP, respectively.
64
Cash Flows and Working Capital
We financed our operations primarily through our available cash in hand as well as cash generated from our operating, financing
and investing activities. As of December 31, 2013, 2014 and 2015, we had RMB157.0 million, RMB181.5 million and RMB49.0 million
(US$7.6 million), respectively, in cash and cash equivalents. The decrease in the cash and cash equivalents from 2014 to 2015 was primarily
due to cash outflows to finance capital investment in a joint venture and operating activities for product development and sales and
marketing, offset by net proceeds from the issuance and sale of the Convertible Notes to Splendid Days and the entrusted loan provided by a
third party in December 2015. The increase in the cash and cash equivalents from 2013 to 2014 was primarily due to the net effect of cash
consideration received from the disposal of Huopu Cloud and the proceeds from the investment made by Shanghai Oriental Pearl Culture
Development Co., Ltd. in Red 5 offset by the net cash outflow from operating activities for product development and sales and marketing.
We have an accumulated deficit of approximately RMB2,304 million (US$355.7 million) as of December 31, 2015, a net loss of
approximately RMB354.2 million (US$54.7 million) for the year ended December 31, 2015, and have not generated significant revenues or
positive cash flows from operations since 2009. We expect to continue to incur product development and sales and marketing expenses for
licensed and proprietary new games in order to achieve revenue growth. To meet our capital needs, we are considering multiple alternatives,
including but not limited to additional equity financings, debt financings, other financing transactions, and cost control, which are discussed
below.
Sales of Equity Interest of Red 5
In March 2016, we entered into a non-binding memorandum of understanding, or MOU, with L&A International Holding
Limited, or L&A, a Cayman Islands company with shares publicly listed on the Growth Enterprise Market of the Hong Kong Stock
Exchange, and certain other shareholders of Red 5. Pursuant to the MOU, we have agreed to exchange approximately 30.6% equity interest
that we own in Red 5 for such number of newly issued shares of L&A which has the same value as the exchanged Red 5 equity interest. The
other participating shareholders of Red 5 will exchange an aggregate of approximately 14.4% equity interest in Red 5 based on the same
terms. The total valuation for the 45% equity interest in Red 5 subject to this exchange is expected to be approximately US$76.5 million,
subject to adjustments by no more than 15% based on the results of due diligence exercises to be conducted by both parties. The completion
of the transaction is subject to the parties’ execution of definitive agreements and customary closing conditions to be stipulated therein. If the
transaction is completed in accordance with valuation of the MOU, we expect to receive ordinary shares of L&A with a valuation ranging
from US$44 million to US$60 million. We expect these shares to be publicly traded and can be traded with any restriction in the public
market in Hong Kong. As a result, we believe that the completion of this transaction can provide a source of funding for our operations.
Additional External Debt Financing
In March 2016, the Bank of Shanghai, or BOS, issued a commitment letter whereby BOS agreed to grant us a one-year credit
facility of RMB50 million (US$7.7 million). We can apply to withdraw loans from the facility if we require liquidity for our operations. As
of March 31, 2016, we had withdrawn RMB4.9 million (US$0.8 million) from this credit facility.
Launch of New Games
We plan to have a large-scale commercial launch of Firefall in China in the second half of 2016. In addition, we plan to launch
our proprietary mobile game Song of Knights in 2016. As of the date of this annual report, we have licensed Song of Knights to different
game operators for distribution in Korea, Vietnam, Taiwan, Malaysia, Hong Kong, Singapore and Macau.
Cost Control
We do not have significant short-term loans or liabilities to third parties. Currently a significant portion of our cash requirements
is attributable to payroll-related costs. We have the ability to control the level of discretionary spending on payroll by reducing our
headcount within a short period of time when necessary.
There can be no assurance that we will be able to successfully complete any of the foregoing transactions or conduct the cost
control measures with results favorable to us, or at all. If we are unable to obtain the necessary capital, we will need to license or sell our
assets, seek to be acquired by another entity and/or cease operations. See “Item 3. Key Information—D. Risk Factors— Risks Related to Our
Company and Our Industry—We may continue to incur losses, negative cash flows from operating activities and net current liabilities in the
future. If we are not able to return to profitability or raise sufficient capital to cover our capital needs, we may not continue as going
concern.”
We believe that, with the foregoing potential sources of cash flow and potential cost control measures, we have sufficient
financial resources to meet our anticipated operating cash flow requirements, to meet our obligations and to pay off liabilities as and when
they fall due for the twelve months following the date of this annual report.
65
We did not have any outstanding balance of bank or other borrowings as of December 31, 2013, 2014 and 2015, except for
an entrustment loan of approximately RMB31.6 million (US$4.9 million) from a third party that we obtained in December 2015.
Pursuant to the relevant entrusted loan agreement dated December 11, 2015, such entrusted loan bears an interest at a rate of 12% per
year, for an initial term of three years, subject to an extension for two years. The loan is secured by a mortgage over our office
building in Shanghai which we currently use as our principal executive offices. As of the date of this annual report, the entire
principal amount of the entrusted loan remained outstanding. In March 2016, Shanghai IT, our affiliated PRC entity, obtained a
commitment letter from the Bank of Shanghai for a one-year credit facility of RMB50 million (US$7.7 million), of which we have
withdrawn RMB4.9 million (US$0.8 million) as of March 31, 2016.
Pursuant to the Convertible Note and Warrant Purchase Agreement dated November 24, 2015, on December 11, 2015, we
issued and sold the Convertible Notes in the aggregate principal amount of US$40,050,000 to Splendid Days Limited, or Splendid
Days. We received net proceeds of US$36,850,000 from the sale of the Convertible Notes. The Convertible Notes are divided for
three tranches in principal amounts of US$22,250,000, US$13,350,000 and US$4,450,000, respectively, which will be convertible at
the option of the holder at any time into our ADSs at initial conversion prices of US$2.6, US$5.2 and US$7.8 per ADS, respectively,
provided that at no time shall the holder convert any portion of the Convertible Notes if subsequent to such conversion such holder
will hold more than 20% of the total outstanding and issued shares of our company. The Convertibles Notes bear interest at a rate of
12% per year, payable when the principal amount of the Convertible Notes becomes due, and have initial terms of three years, subject
to an extension for two years at the discretion of the holder. The initial conversion prices are subject to adjustments for share splits,
reverse splits, share dividends and distributions, and certain issuances (or deemed issuances) of ordinary shares or ADSs for
consideration less than the conversion price then in effect. In addition, the holder of the Convertible Notes is entitled to any
extraordinary cash dividend (to the extent that it exceeds the accrued interest amount per share) and dividend in kind that we
distribute based on the number of shares into which the Convertible Notes are then convertible. Following a “change of control,” as
such term is defined in the Convertible Notes, the holder of the Convertible Notes will be entitled to require us to redeem all or part of
the Convertible Notes, at a price payable in cash equal to 100% of the outstanding principal amount of the Convertible Notes, plus all
accrued and unpaid interests thereon, if any. In addition, pursuant to the terms of the Convertible Notes, if there is a continuing event
of default, the holder will be entitled to declare any of the Convertible Notes immediately due and payable, and request redemption
by us at a price equal to the outstanding principal amount plus all accrued and unpaid interests thereon, if any. “Events of default” as
defined in the Convertible Notes include, among other things, an event of default under any indebtedness in the amount exceeding
US$500,000.
Pursuant to the same agreement, on December 11, 2015, we issued to Splendid Days four tranches of warrants in an
aggregate principal amount of US$9,950,000. The Warrants are divided into four tranches in principal amounts of US$5,000,000,
US$2,750,000, US$1,650,000 and US$550,000, respectively, which will be exercisable for our ADSs at the option of the holder at
any time at initial exercise prices of US$1.5, US$2.6, US$5.2 and US$7.8 per ADS, respectively. The initial exercise prices are
subject to adjustments for share splits, reverse splits, share dividends and distributions, distribution of assets, certain issuances (or
deemed issuances) of ordinary shares or ADSs for consideration less than the exercise price then in effect, as applicable for each
warrant. In addition, the holder of the Warrants with initial exercise prices of US$2.6, US$5.2 and US$7.8 per ADS is entitled to any
cash dividend (to the extent that it exceeds the notional interest amount attributable to such Warrants) and dividend in kind that we
distribute based on the number of shares into which the Warrants are then exercisable. The tranche of Warrants with an exercise price
of US$1.5 per ADS has a term of five years, while the remaining three tranches have initial terms of three years, subject to an
extension for two years if the holder exercises its discretion to extend the term of the Convertible Notes. The Convertible Notes are
secured by a pledge of our 100% equity interests in two of our wholly-owned subsidiaries in China, including The9 Computer and
C9I Shanghai, and a mortgage over our office building in Shanghai which we currently use as our principal executive
offices. Pursuant to the agreement, we will register the ordinary shares into which the Convertible Notes are convertible and the
Warrants are exercisable on a registration statement on F-3, and use our best efforts to cause such registration statement to be
declared effective by the SEC as promptly as possible after the initial filing.
The following table sets forth the summary of our cash flows for the periods indicated:
Net cash used in operating activities
Net cash (used in)/provided by investing activities
Net cash (used in)/provided by financing activities
Effect of foreign exchange rate changes on cash
Net (decrease)/increase in cash and cash equivalents
Cash and cash equivalents at beginning of year
Cash and cash equivalents at end of year
66
2013
RMB
For the Year Ended December 31,
2015
RMB
2014
RMB
US$
(in thousands)
(357,570) (269,098) (175,587) (27,106)
(2,932) 197,752 (208,996) (32,263)
(38,689) 100,222 257,937 39,818
(899)
(4,381)
1,899
(397,292)
24,495 (132,472) (20,450)
554,279 156,987 181,482 28,016
156,987 181,482 49,011 7,566
(5,826)
Operating Activities
Net cash used in operating activities was RMB175.6 million (US$27.1 million) in 2015, compared to RMB269.1 million in
2014 and RMB357.6 million in 2013. The decreases of net cash used in operating activities from 2013 to 2014 and from 2014 to 2015
were mainly due to decreases in cash outflow associated with product development and sales and marketing expenses. In particular,
the net cash used in operating activities in 2015 primarily reflected a net loss of RMB354.2 million (US$54.7 million) in 2015,
partially offset by the adjustments for share-based compensation expense of RMB34.0 (US$5.2 million), changes in due to related
party of RMB61.5 million (US$9.5 million) primarily due to the receipt of the initial license fee of Firefall in China, amortization of
intangible assets of RMB19.1 million (US$2.9 million), depreciation and amortization of property, equipment and software of
RMB11.6 million (US$1.8 million) and allowance of receivables of RMB8.4 (US$1.3 million). The net cash used in operating
activities in 2014 primarily reflected a net loss of RMB128.9 million in 2014 and the gain on disposal of subsidiary of RMB165.4
million, partially offset by the adjustments for amortization of intangible assets of RMB28.9 million and depreciation and
amortization of property, equipment and software of RMB15.7 million. The net cash used in 2013 primarily reflected a net loss of
RMB562.9 million, partially offset by an adjustment for impairment loss on other long-lived assets of RMB29.7 million, an
adjustment for impairment loss on investments of RMB48.0 million, and an adjustment for a stock-based compensation expenses of
RMB29.2 million.
Investing Activities
Net cash used in investing activities was RMB209.0 million (US$32.3 million) in 2015, which primarily included (i) cash
used for investment in System Link of RMB223.4 million (US$34.5 million), (ii) loan receivable due from ZET9 of RMB9.9 million
(US$1.5 million), and (iii) capital expenditures including purchase of property, equipment and software of RMB10.6 million
(US$1.6 million), partially offset by collection of long-term receivable from WoW game points refund agent which amounted to
RMB17.9 million (US$2.8 million) and receipt of proceeds of RMB12.2 million (US$1.9 million) in connection with the disposal of
our equity interest in Kai Yue.
Net cash provided by investing activities was RMB197.8 million in 2014, which primarily included (i) proceeds from
disposal of subsidiaries of RMB163.7 million relating to Huopu Cloud and Kai Yue, (ii) proceeds from disposal of equity investees of
RMB25.0 million and proceeds from disposal of available-for-sale investment of RMB6.3 million, relating to Beijing Linkage,
Tandem Fund and Youjia, (iii) proceeds from refund of upfront license fees and upfront property, equipment and software purchase
payment of RMB4.0 million, partially offset by the cash used for capital expenditures including purchase of property, equipment and
software of RMB3.1 million.
Net cash used in investing activities was RMB2.9 million in 2013, which primarily included purchase of property,
equipment and software of RMB7.1 million, and cash paid to acquire equity investees and available-for-sale investments of
RMB9.2 million relating to ZTE9 and Tandem Fund, partially offset by proceeds from refund of our investment in G10
Entertainment Corporation, a Korean online game developer and operator, of RMB7.3 million and our investments relating to the sale
of OpenFeint of RMB5.5 million.
Financing Activities
Net cash provided by financing activities in 2015 was RMB258.0 million (US$39.8 million), primarily attributable to the
issuance and sale of the Convertible Notes in the aggregate principal amount of US$40,050,000 to Splendid Days in December 2015
and an entrusted loan of RMB31.6 million (US$4.9 million) provided by a third party. Net cash provided by financing activities in
2014 was RMB100.2 million, primarily attributable to issuance of redeemable noncontrolling interest relating to the investment made
by Shanghai Oriental Pearl Culture Development Co., Ltd. in Red 5 of RMB118.3 million. Net cash used in financing activities in
2013 was RMB38.7 million, primarily attributable to cash used to repurchase our ADSs in the amount of RMB29.0 million, partially
offset by cash generated from stock option exercises in the amount of RMB4.3 million.
67
As a result of non-renewal of WoW license on June 7, 2009, we announced a refund plan in connection with unactivated
WoW game point cards. According to the plan, unactivated WoW game point card holders are eligible to receive a cash refund from
us. We recorded a liability in connection with both unactivated points cards and activated but unconsumed point cards of
approximately RMB200.4 million, of which RMB4.0 million was refunded in 2009. Upon the loss of the WoW license, we concluded
that the nature of the obligation substantively changed from deferred revenue, for which we had the ability to satisfy the underlying
performance obligation, to an obligation to refund players for their unconsumed points. Thus, we have accounted for this refund
liability by applying the relevant derecognition guidance when determining the proper accounting treatment. In accordance with this
guidance, the refund liability associated with these WoW game points, to the extent not refunded, will be recorded as other operating
income after we are legally released from the obligation to refund amounts under the applicable laws. As we announced the refund
plan on September 7, 2009, the statute of limitations of the creditors (in this case the game players with claims for refund of
unactivated WoW game point cards) to assert their claims for refund is two years from such date under applicable laws and thus our
legal liability relating to the unactivated WoW game point cards was extinguished on September 7, 2011 and the associated liability
amounting to RMB26.0 million was recognized as other operating income for the year ended December 31, 2011. With respect to the
remaining refund liability, based on current PRC laws, to the extent not refunded, we, in consultation with legal counsel, have
determined that we will be legally released from this liability in 2029, which represents 20 years from the date of discontinuation of
WoW in 2009. However, if management were to publicly announce a refund policy, we would be legally released from any
remaining liability for these activated, but unconsumed points, sooner than 20 years. To date, we have determined not to publicly
announce any refund policy with respect to this remaining liability, and no refunds have been claimed. The remaining refund liability
relating to the activated, but unconsumed WoW game points was RMB170.0 million (US$26.2 million) as of December 31, 2015.
Capital Expenditures
We incurred capital expenditures of RMB21.6 million, RMB22.6 million and RMB30.1 million (US$4.7 million) in 2013,
2014 and 2015, respectively. The capital expenditures principally consisted of purchases of servers, computers and other items related
to our network infrastructure and license fees. If we license new games or enter into strategic joint ventures or acquisitions, we may
require additional funds for necessary capital expenditures.
C. Research and Development, Patents and Licenses, etc.
Our research and development efforts are primarily focused on the development of our proprietary online games, the
localization of licensed games from foreign developers, and the maintenance of our websites. Our research and development expenses
were RMB213.2 million, RMB156.3 million and RMB135.0 million (US$20.8 million) in 2013, 2014 and 2015, respectively.
D. Trend Information
Other than as disclosed elsewhere in this annual report, we are not aware of any trends, uncertainties, demands,
commitments or events for the period from January 1, 2015 to December 31, 2015 that are reasonably likely to have a material
adverse effect on our net sales or revenues, results of operations, profitability, liquidity or capital resources, or that would cause the
reported financial information not necessarily to be indicative of future operating results or financial conditions.
E. Off-Balance Sheet Arrangements
We have not entered into any financial guarantees or other commitments to guarantee the payment obligations of any third
parties. We have not entered into any off-balance sheet derivative instruments. Furthermore, we do not have any retained or
contingent interest in assets transferred to an unconsolidated entity that serves as credit, liquidity or market risk support to such entity.
We do not have any variable interest in any unconsolidated entity that provides financing, liquidity, market risk or credit support to us
or engages in leasing, hedging or research and development services with us.
68
F. Contractual Obligations
The following table sets forth our contractual obligations and other commitments under as of December 31, 2015:
Total
Less than 1 year
Payments Due by Period
1-2 years
(RMB)
3-5 years
More than 5 years
Long-term borrowings(1)
Convertible notes payable(2)
Interest expense on long-term borrowings and
notes payable
Operating lease obligations(3)
31,624,560
260,068,679
—
—
—
—
31,624,560
260,068,679
105,000,724
34,281,716
—
—
8,389,540 7,159,779
105,000,724
18,732,397
—
—
—
—
(1) Long-term borrowings include (i) an entrusted loan of approximately RMB31.6 million (US$4.9 million) obtained from a third
party.
(2) Represents the Convertible Notes in an aggregate principal amount of US$40,050,000 which bear interest at a rate of 12% per
year, payable when the principal amount of the Convertible Notes becomes due. The Convertible Notes have initial terms of
three years, subject to an extension to five years at the discretion of the holder.
(3) We have entered into leasing arrangements related to the use of certain office premises and Internet data centers.
G.
Safe Harbor
This annual report on Form 20-F contains statements of a forward-looking nature. These statements are made under the
“safe harbor” provisions of the U.S. Private Securities Litigation Reform Act of 1995. You can identify these forward-looking
statements by terminology such as “may,” “will,” “expects,” “anticipates,” “future,” “intend,” “plan,” “believe,” “estimate,” “is/are
likely to” or other and similar expressions. The accuracy of these statements may be impacted by a number of risks and uncertainties
that could cause actual results to differ materially from those projected or anticipated. Such risks and uncertainties include, but are not
limited to, the following:
•
•
•
•
•
•
•
•
•
our ability to successfully launch and operate additional games in China and overseas;
our ability to develop, license or acquire additional online games that are attractive to users;
the maintenance and expansion of our relationships with game distributors and online game developers, including
our existing licensors;
uncertainties in and the timeliness of obtaining necessary governmental approvals and licenses for operating any
new online game;
risks inherent in the online game business;
risks associated with our future acquisitions and investments;
our ability to compete effectively against our competitors;
risks associated with our corporate structure and the regulatory environment in China; and
other risks outlined in our filings with the SEC including this annual report on Form 20-F.
These risks are not exhaustive. We operate in an emerging and evolving environment. New risk factors emerge from time
to time and it is impossible for our management to predict all risk factors, nor can we assess the impact of all factors on our business
or the extent to which any specific factor, or combination of factors, may cause actual results to differ materially from those contained
in any forward-looking statements.
We would like to caution you not to place undue reliance on forward-looking statements and you should read these
statements in conjunction with the risk factors disclosed in “Item 3. Key Information—D. Risk Factors.” We do not undertake any
obligation to update forward-looking statements except as required under applicable law.
69
Item 6.
DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES
A. Directors and Senior Management
The following table sets forth information regarding our directors and executive officers as of the date of this annual report.
Directors and Executive Officers
Jun Zhu
Davin Alexander Mackenzie(1)(2)
Kwok Keung Chau(1)(2)
Ka Keung Yeung(1)(2)
George Lai
Chris Shen
(1) Member of Audit Committee.
(2) Member of Compensation Committee.
Biographical Information
Position/Title
Age
49 Chairman of the Board and Chief Executive Officer
55
39
56
39 Chief Finance Officer and Director
47 Vice President
Independent Director
Independent Director
Independent Director
Jun Zhu is one of our co-founders. He has served as the chairman of our board of directors and chief executive officer since
our inception. Prior to founding The9, Mr. Zhu co-founded Flagholder New Technology Co. Ltd., an information technology company
based in China, in 1997, and served as its director from 1997 to 1999. From 1993 to 1997, Mr. Zhu worked at QJ (U.S.A.) Investment,
Ltd., a trading company in the United States. Mr. Zhu attended an undergraduate program at Shanghai Jiaotong University.
Davin Alexander Mackenzie has served as our independent director since July 2005. Mr. Mackenzie is currently a consultant
of Spencer Stuart Beijing Office, a renowned global executive search company. Mr. Mackenzie is also a director of MicroCred Group, a
France-based investment company, Sports Beijing, a non-profit recreational youth sports organization, and a director of Mountain
Hazelnut Ventures, a private agricultural company. From 2009 to 2011, Mr. Mackenzie was the Beijing representative of Brocade
Capital Limited, a private equity advisory firm that he founded in 2009. From 2008 to 2009, Mr. Mackenzie was the managing director
and Beijing representative of Arctic Capital Limited, a pan-Asia private equity advisory firm. Between 2000 and 2008, Mr. Mackenzie
held the same positions in Peak Capital LLC, another private equity investment and advisory firm that focuses on the China market.
Prior to Peak Capital, Mr. Mackenzie worked with the International Finance Corporation, a private sector arm of The World Bank
Group, for seven years, including four years as the resident representative for China and Mongolia. Mr. Mackenzie has also worked at
Mercer Management Consultants in Washington, D.C., and at First National Bank of Boston in Taiwan. Mr. Mackenzie received a
bachelor’s degree in Government from Dartmouth College. He received a master’s degree in international studies and an MBA degree
from the Wharton School of Business at the University of Pennsylvania. Mr. Mackenzie has also completed the World Bank Executive
Development Program at Harvard Business School.
Kwok Keung Chau has served as our independent director since October 2015. Mr. Chau is an executive director, the chief
financial officer and the company secretary of Comtec Solar Systems Group Limited, a Hong Kong listed company (Stock Code: 712),
responsible for corporate financial and general management. He currently also serves as an independent non-executive director and the
chairman of the audit committee of Qingdao Port International Co., Ltd., a Hong Kong listed company (Stock Code: 6198). He acted as
a member of supervisory board of RIB Software AG, a software company in Germany, which was listed in Frankfurt Stock Exchange,
from May 2010 to June 2013. Prior to joining Comtec Solar in November 2007, Mr. Chau served in various positions at China.com Inc.,
a Hong Kong listed company (Stock Code: 8006) from October 2005 to October 2007, including vice president of the finance
department, chief financial officer, company secretary and authorised representative. Prior to joining China.com Inc., Mr. Chau had
several years of experience in finance at different companies and a professional firm. Mr. Chau has been a fellow member of the
Association of Chartered Certified Accountants since June 2002, a member of the Hong Kong Institute of Certified Public Accountants
since July 2005 and a Chartered Financial Analyst of the CFA Institute since September 2003. Mr. Chau received his bachelor’s degree
in business administration from the Chinese University of Hong Kong in May 1998.
Ka Keung Yeung has served as our independent director since July 2005. Mr. Yeung is the executive vice president and chief
financial officer of Phoenix Satellite Television Holdings Limited, or Phoenix, a listed company in Hong Kong, and is in charge of
corporate finance and administration. He is also the company secretary and qualified accountant. Mr. Yeung joined Phoenix in March
1996 and is in charge of all of Phoenix’s internal and external financial management and arrangements and also supervises
administration and personnel matters. Mr. Yeung also serves as a director of Phoenix New Media, a subsidiary of Phoenix and a
company listed on the NYSE. Mr. Yeung graduated from the University of Birmingham and is qualified as a chartered accountant. Upon
returning to Hong Kong, he worked at Hutchison Telecommunications and STAR in the fields of finance and business development.
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George Lai has served as our chief financial officer since July 2008 and our director since January 2016. Prior to joining
us, Mr. Lai worked for Deloitte Touche Tohmatsu since 2000. Mr. Lai worked in several different Deloitte offices, including Hong
Kong, New York and Beijing. During his eight years at Deloitte, Mr. Lai played key roles in the audit function in a number of IPO
projects in the United States and China. He also assisted public companies in the United States, Hong Kong and China with a wide
range of accounting matters. Mr. Lai received his bachelor of business administration, with a focus in professional accountancy, from
the Chinese University of Hong Kong. Mr. Lai holds various accounting professional qualifications, including from AICPA, FCCA
and HKICPA.
Chris Shen has served as our vice president since January 2006. Mr. Shen joined us in August 2005 as our senior director
of marketing and is in charge of our mobile social gaming platform and marketing and public relations activities. Prior to joining us,
Mr. Shen served as the group account director and account director for several renowned advertising agencies in Shanghai and Taipei,
mainly serving multinational companies in various industries, such as consumer goods, financial services and retail. During the past
twelve years, Mr. Shen helped numerous local and international brands plan and executed various marketing initiatives. Mr. Shen
received his bachelor’s degree in management science from the National Chiao Tung University in Taiwan.
B. Compensation
Compensation of Directors and Executive Officers
In 2015, the aggregate cash compensation paid to our executive officers was approximately RMB5.5 million (US$0.9
million). We paid a total of RMB1.2 million (US$0.2 million) in cash to our non-executive directors for their services in 2015. No
director or executive officer is entitled to any severance benefits upon termination of his or her employment with or appointment by
our company. On December 8, 2010, we granted 1,500,000 ordinary shares to Jun Zhu, our chairman and chief executive officer,
which will only be vested if our company achieves certain income targets and the shares are not entitled to receive dividends until
they become vested. Of such shares, 500,000 ordinary shares were vested and issued to Incsight Limited, a company wholly owned
by Jun Zhu, on November 17, 2015. In May 2011, our board of directors granted 30,000 ordinary shares to each of our four non-
executive directors then in office, of which 10,000 ordinary shares vest for each director on July 1 of each year from 2011 to 2013 so
long as such director continues his services as of such date. An aggregate of 40,000 ordinary shares, 40,000 ordinary shares and
40,000 ordinary shares were vested in July 2011, 2012 and 2013, respectively. The fair value of the shares granted was US$6.03 per
share, being the market price on the date of the grant.
Share Incentive Plan
Fifth Amended and Restated 2004 Stock Option Plan
Our board of directors and our shareholders have adopted and approved the 2004 Stock Option Plan, or the Option Plan, in
2004 in order to attract and retain the best available personnel for positions of substantial responsibility, to provide additional
incentives to employees, directors and consultants and to promote the success of our business. The Option Plan was amended and
restated in December 2006, November 2008, August 2010, November 2010 and November 2015. By the last amendment and
restatement in November 2015, we increased the total number of ordinary shares reserved under the Option Plan from 6,449,614 to
14,449,614. As of February 29, 2016, options to purchase 12,877,718 ordinary shares under the Option Plan were outstanding. In
April 2013, our board of directors approved an adjustment to the exercise price of options to purchase 2,829,941 shares previously
granted from 2008 to 2011 under our Option Plan to establish a new exercise price for such share options at US$2.41 per ADS, which
was the closing price of our ADSs as of April 22, 2013. In November 2015, our board of directors approved an adjustment to the
exercise price of options to purchase 4,629,100 shares previously granted from 2010 to 2015 under our Option Plan to establish a new
exercise price for such share options at US$1.53 per ADS, which was the closing price of our ADSs on November 9, 2015.
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The following table provides a summary of the options granted to our directors, executive officers and other individuals as
a group under the Option Plan as of February 29, 2016 and that remained outstanding.
Jun Zhu
Davin Alexander Mackenzie
Kwok Keung Chau
Ka Keung Yeung
George Lai
Chris Shen
All Directors and Senior Executive
Officers as a Group†
Other Individuals as a Group (other
than those listed above)
Total Number of
Ordinary Shares
Underlying Options
Outstanding†
8,000,000
610,000
500,000
610,000
907,900
*
Exercise
Price
(in US$)
Expiration date
June 13, 2020 – November 17, 2020
1.53
1.53 April 22, 2018 – November 17, 2020
1.53
1.53 April 22, 2018 – November 17, 2020
1.53 April 22, 2018 – November 17, 2020
1.53 August 27, 2020 – November 17, 2020
November 17, 2020
10,947,900
1.53 April 22, 2018 – November 17, 2020
1,929,818
1.53
June 13, 2020 – November 17, 2020
† Excluding 2,937,844 options forfeited and 1,450,971 options exercised as of February 29, 2016 pursuant to the terms of our Option
Plan.
* The options held by this executive officer represent less than 1% of our total outstanding shares.
Termination of Options. Where the option agreement permits the exercise or purchase of the options granted for a certain
period of time following the recipient’s termination of service with us, or the recipient’s disability or death, the options will terminate
to the extent not exercised or purchased on the last day of the specified period or the last day of the original term of the options,
whichever occurs first.
Administration. Our stock option plan is administered by our board of directors or an option administrative committee
designated by our board of directors and constituted to comply with applicable laws. In each case, our board of directors or the
committee it designates will determine the provisions, terms and conditions of each option grant, including, but not limited to, the
option vesting schedule, repurchase provisions, forfeiture provisions, form of payment upon settlement of the award, payment
contingencies and satisfaction of any performance criteria.
Vesting Schedule. Options granted under our stock option plan vest over a two to four year period following a specified
vesting commencement date. In general, the options granted will vest over the vesting period on a monthly basis, subject to the
recipient of the options continuing to be employed by us on each vesting date.
Option Agreement. Options granted under our stock option plan are evidenced by an option agreement that contains,
among other things, provisions concerning exercisability and forfeiture upon termination of employment or consulting arrangements,
as determined by our board. In addition, the option agreement also provides that options granted under our stock option plan are
subject to a 180-day lock-up period following the effective date of a registration statement filed by us under the Securities Act, if so
requested by us or any representative of the underwriters in connection with any registration of the offering of any of our securities.
Option Exercise. The term of options granted under our stock option plan may not exceed five years from the date of grant.
The consideration to be paid for our shares upon exercise of an option or purchase of shares underlying the option will be determined
by the plan administrator and may include cash, check, ordinary shares, a promissory note, consideration received by us under a
cashless exercise program implemented by us in connection with our stock option plan, or any combination of the foregoing methods
of payment.
Third-Party Acquisition. If a third party acquires us through the purchase of all or substantially all of our assets, a merger
or other business combination, all outstanding options or share purchase rights will be assumed or equivalent options or rights
substituted by the successor corporation or parent or subsidiary of the successor corporation. In the event that the successor
corporation refuses to assume or substitute for the options or share purchase rights, all options or share purchase rights will become
fully vested and exercisable immediately prior to such transaction and all unexercised awards will terminate unless, in either case, the
awards are assumed by the successor corporation or its parent.
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Changes in Capitalization and Other Adjustments. If we shall at any time increase or decrease the number of outstanding
shares, or change in any way the rights and privileges of our outstanding shares, by means of a payment or a stock dividend or any
other distribution upon such ordinary shares, or through a stock split, subdivision, consolidation, combination, reclassification or
recapitalization involving such ordinary shares, then in relation to the ordinary shares that are covered by the options granted or
available under the plan and are affected by one or more of the above events, the number, rights and privileges shall be increased,
decreased or changed in like manner as if such ordinary shares had been issued and outstanding, fully paid and non-assessable at the
time of such occurrence.
Termination of Plan. Unless terminated earlier, our stock option plan will expire in 2024. Our board of directors has the
authority to amend, alter, suspend or terminate our stock option plan. However, no such action may (i) impair the rights of any
optionee unless agreed by the optionee and the stock option plan administrator, or (ii) affect the stock option plan administrator’s
ability to exercise the powers granted to it under our stock option plan.
C. Board Practices
Board of Directors
Our board of directors consists of the following five directors: Jun Zhu, Kwok Keung Chau, Davin Mackenzie, Ka Keung
Yeung and George Lai. A director is not required to hold any shares in our company by way of qualification. A director may vote
with respect to any contract, proposed contract or arrangement in which he is materially interested so long as he has disclosed the
nature of the interest at a meeting of the directors. A director may exercise all the powers of our company to borrow money, mortgage
its undertaking, property and uncalled capital, and issue debentures or other securities whenever money is borrowed or as security for
any obligation of our company or of any third party.
Committees of the Board of Directors
Audit Committee. Our audit committee consists of Messrs. Kwok Keung Chau, Davin A. Mackenzie and Ka Keung
Yeung, all of whom satisfy the “independence” definition under Rule 5605 of the Nasdaq Stock Market, Inc. Marketplace Rules, or
the Nasdaq Rules, and the audit committee independence standard under Rule 10A-3 under the Exchange Act. All the members of our
audit committee meet the “financial expert” definition of the Nasdaq Rules.
The audit committee oversees our accounting and financial reporting processes and the audits of the financial statements of
our company. The audit committee is responsible for, among other things:
•
•
•
•
•
•
•
selecting the independent auditors and pre-approving all auditing and non-auditing services permitted to be
performed by the independent auditors;
reviewing and approving all proposed related-party transactions;
discussing the annual audited financial statements with management and the independent auditors;
annually reviewing and reassessing the adequacy of our audit committee charter;
meeting separately and periodically with management and the independent auditors;
reporting regularly to the full board of directors; and
such other matters that are specifically delegated to our audit committee by our board of directors from time to time.
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Compensation Committee. Our compensation committee consists of Messrs. Kwok Keung Chau, Davin A. Mackenzie and
Ka Keung Yeung, all of whom meet the “independence” standards for compensation committee members under the Nasdaq Rules.
The compensation committee assists the board in reviewing and approving the compensation structure of our executive officers,
including all forms of compensation to be provided to our executive officers. The compensation committee will be responsible for,
among other things:
•
•
•
•
•
reviewing and determining the compensation for our five most senior executives;
reviewing the compensation of our other employees and recommending any proposed changes to the management;
reviewing and approving director and officer indemnification and insurance matters;
reviewing and approving any employee loans in an amount equal to or greater than US$60,000 (or such amount as
from time to time announced by the relevant regulatory bodies as requiring the approval of the Committee); and
reviewing periodically and approving any long-term incentive compensation or equity plans, programs or similar
arrangements, annual bonuses, employee pensions and welfare benefits plans.
Duties of Directors
Under Cayman Islands law, our directors have fiduciary duties to act honestly, in good faith and with a view to our best
interests. Our directors also owe to our company a duty to act with skill and care. It was previously considered that a director need not
exhibit in the performance of his duties a greater degree of skill than may reasonably be expected from a person of his knowledge and
experience. However, English and Commonwealth courts have moved towards an objective standard with regard to the required skill
and care and these authorities are likely to be followed in the Cayman Islands. In fulfilling their duty of care to us, our directors must
ensure compliance with our memorandum and articles of association, as amended and restated from time to time. We have the right to
seek damages if a duty owed by our directors is breached.
Terms of Directors
Our board of directors is currently divided into three classes with different terms. This provision would delay the
replacement of a majority of our directors and would make changes to the board of directors more difficult than if such provision
were not in place. Our independent directors, namely Kwok Keung Chau, Davin A. Mackenzie and Ka Keung Yeung, were re-elected
(elected in the case of Kwok Keung Chau) at our 2015 annual general meeting and each of them is serving a three-year term until the
2018 annual general meeting or until his successor is duly elected and qualified, whichever is earlier. Jun Zhu, our chairman and chief
executive officer, was re-elected as a director at our 2013 annual general meeting and is serving a three-year term until the 2016
annual general meeting or until his successor is duly elected and qualified, whichever is earlier. George Lai, our chief financial
officer, who was appointed by our board of directors as a director to fill a casual vacancy on our board of directors, holds office until
our 2016 annual general meeting or until his successor is duly elected and qualified, whichever is earlier. Upon expiration of the term
of office of each class, succeeding directors in each class will be elected for a term of three years. Directors may be removed from
office by ordinary resolution of shareholders at any time before the expiration of his/her term. Pursuant to the natural expiration of the
directorial terms, elections for directors would be held on the date of the annual general meeting of shareholders.
Voting Agreement
On November 26, 2004, Incsight and Bosma, our two largest shareholders, entered into a voting agreement with respect to
the election of our board of directors. Both parties have agreed to vote their respective shares to ensure that our board of directors
consists of: (i) one director designated by Incsight, so long as it holds 5% or more of our total outstanding shares, which is currently
Jun Zhu; (ii) one director designated by Bosma, so long as it holds 5% more of our total outstanding shares; (iii) two individuals
mutually acceptable to Incsight and Bosma, but who are not otherwise affiliated with either of them, our company or any of our
shareholders; and (iv) an additional individual who is not affiliated with either Incsight, Bosma, our company or any of our
shareholders. Both parties agreed to vote to ensure that none of the directors elected pursuant to the voting agreement shall be
removed from office, except for cause or unless by the affirmative vote of both parties. In addition, each of Incsight and Bosma
agrees to elect one or two individuals designated by the other party as directors so long as each of them holds not less than 20% of the
total issued shares of our company. The voting agreement shall continue until both parties mutually agree in writing to terminate it.
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D. Employees
As of December 31, 2015, we had 565 employees, among which 429 were based in China, including 59 in management
and administration, 41 in our customer service centers, 82 in game operations, sales and marketing, and 247 in product development,
including supplier management personnel and technical support personnel, 133 were based in the United States and three were based
in other regions. We had 611 and 498 employees as of December 31, 2013 and 2014, respectively. The decrease in the number of
employees as of December 31, 2014 as compared to that of December 31, 2013 was primarily due to our disposal of Huopu Cloud.
We consider our relations with our employees to be good.
E.
Share Ownership
As of February 29, 2016, there were 37,283,929 ordinary shares outstanding, including 26,971,530 ordinary shares issued
to The Bank of New York Mellon, our ADS depositary, to facilitate our future issuance of ADSs upon the exercise of options under
our share incentive plan.
The following table sets forth information with respect to the beneficial ownership of our ordinary shares as of
February 29, 2016 by:
•
•
each of our directors and executive officers who are also our shareholders; and
each person known to us to own beneficially more than 5% of our ordinary shares.
Directors and Executive Officers:
Jun Zhu(3)
Davin Alexander Mackenzie(4)
Kwok Keung Chau
Ka Keung Yeung(5)
George Lai(6)
Chris Shen
All Directors and Senior Executive Officers as a Group(7)
Principal Shareholders:
Incsight Limited(8)
Splendid Days Limited(9)
Bosma Limited(10)
Quality Event Limited(11)
Ordinary Shares Beneficially Owned
Number(1)
%(2)
11,786,282
396,565
*
396,115
381,498
*
13,465,956
7,019,428
11,974,826
4,612,522
4,393,159
28.0%
1.1%
*
1.1%
1.0%
*
30.8%
18.8%
24.3%
12.4%
11.8%
*
(1)
Less than 1% of our total outstanding shares.
Beneficial ownership is determined in accordance with the rules of the SEC, and includes voting or investment power with
respect to the securities. In computing the number of shares beneficially owned by a person and the percentage ownership of
that person, we have included shares that the person has the right to acquire within 60 days of February 29, 2016, including
through the exercise of any option, warrant or other right or the conversion of any other security.
75
(2)
(3)
(4)
(5)
(6)
(7)
(8)
(9)
Percentage of beneficial ownership is based on 37,283,929 ordinary shares outstanding as of February 29, 2016, as well as the
shares underlying share options and warrants exercisable by such person or group within 60 days from February 29, 2016.
Includes (i) 6,107,334 ordinary shares and 912,094 ordinary shares represented by ADSs held by Incsight Limited, a British
Virgin Islands company wholly-owned and controlled by Jun Zhu, and (ii) 4,766,854 ordinary shares that Jun Zhu has the right
to acquire upon exercise of options within 60 days after February 29, 2016.
Includes (i) 30,450 ordinary shares represented by ADSs held by Mr. Mackenzie and (ii) 366,115 ordinary shares that Mr.
Mackenzie has the right to acquire upon exercise of options within 60 days after February 29, 2016.
Includes (i) 30,000 ordinary shares represented by ADSs held by Mr. Yeung and (ii) 366,115 ordinary shares that Mr. Yeung
has the right to acquire upon exercise of options within 60 days after February 29, 2016.
Includes 381,498 ordinary shares that Mr. Lai has the right to acquire upon exercise of options within 60 days after February
29, 2016.
Includes ordinary shares, ordinary shares represented by ADSs and ordinary shares issuable upon exercise of options held by
all of our directors and executive officers as a group.
Includes 6,107,334 ordinary shares and 912,094 ordinary shares represented by ADSs held by Incsight Limited, a British
Virgin Islands company wholly-owned and controlled by Jun Zhu. The business address for Incsight Limited is Building No. 3,
690 Bibo Road, Zhangjiang Hi-Tech Park, Pudong New Area, Shanghai 201203, People’s Republic of China.
Includes an aggregate 7,195,982 ADSs issuable upon conversion of the Convertible Notes and an aggregate 4,778,844 ADSs
issuable upon exercise of the Warrants within 60 days of December 21, 2015 that are beneficially owned by Splendid Days
Limited, or Splendid Days, as reported by Splendid Days on the Schedule 13D filed with the SEC on December 21,
2015. Splendid Days currently holds all of the Convertible Notes and the Warrants that we issued in December 2015, and it
may not convert any portion of the Convertible Notes if subsequent to such conversion it will hold more than 20% of our total
outstanding and issued ordinary shares. According to the Schedule 13D, Splendid Days, a British Virgin Islands company, Ark
Pacific Investment Management Limited, a company organized under the laws of Cayman Islands, Ark Pacific Special
Opportunities Fund I, L.P., an exempted limited partnership organized under the laws of Cayman Islands, and Ng Chi Keung
Kenneth, a PRC citizen, share the voting and dispositive powers with respect to the aggregate 11,974,826 ADSs. The
percentage of beneficial ownership reported herein was calculated based on the total number of outstanding shares of our
company as of February 29, 2016. The address for Splendid Days Limited is Sea Meadow House, Blackburne Highway, (P.O.
Box 116), Road Town, Tortola, British Virgin Islands.
(10) Consists of 4,145,065 ordinary shares and 467,457 ADSs held by Bosma Limited, as reported by Bosma Limited on the
(11)
Schedule 13G/A filed with the SEC on February 13, 2009. Bosma Limited, a British Virgin Islands corporation, is wholly-
owned by Morningside VC Limited, a British Virgin Islands corporation, which is in turn wholly-owned by The HCB Trust, an
Isle of Man trust, the trustee of which is Dunn Investments Limited, an Isle of Man corporation. Dunn Investments Limited
controls indirectly, through The HCB Trust, a 100% interest in Bosma Limited, and as a result has the sole power to vote and
dispose of the shares of our company held by Bosma Limited. Dunn Investments Limited is controlled by its board of
directors, consisting of Lorna Irene Cameron and Philip Alvaro Salazar, both of whom expressly disclaim beneficial ownership
of the shares held by Bosma Limited. The address for Bosma Limited is Pasea Estate, Road Town, Tortola, British Virgin
Islands.
Includes 2,058,760 ADSs issuable upon conversion of the Convertible Notes and 2,334,399 ADSs issuable upon exercise of
the Warrants within 60 days of December 21, 2015 that are beneficially owned by Quality Event Limited, as reported by
Quality Event Limited on the Schedule 13G filed with the SEC on December 21, 2015. According to the Schedule 13D filed
by Splendid Days with the SEC on December 21, 2015, Quality Event Limited has acquired beneficial ownership over such
ADSs through a participation agreement entered into with Splendid Days and other parties effective on December 4, 2015.
According to the Schedule 13G that it filed, Quality Event Limited, a British Virgin Islands company, is a wholly-owned
subsidiary of Verdant Private Portfolios, a Cayman Islands company, which is a wholly-owned subsidiary of Verdant
Investment Holdings Ltd., a British Virgin Islands company. Verdant Investment Holdings Ltd. is a wholly-owned subsidiary
of Verdant Holdings Limited, a Hong Kong company, which is a wholly-owned subsidiary of Jing An Equity Investment
Company Limited, a PRC company. Jing An Equity Investment Company Limited is a wholly-owned subsidiary of National
Property Company Limited, a PRC company, of which the controlling shareholder is Jin Xi, a PRC citizen. The percentage of
beneficial ownership was calculated based on the total number of outstanding shares of our company as of February 29, 2016.
The address for Quality Event Limited is 21/F, York House, The Landmark, 15 Queen’s Road Central, Hong Kong.
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To our knowledge, as of February 29, 2016, 26,971,530 ordinary shares represented by the ADSs, or approximately 72.3%
of the issued and outstanding shares, were held by one record shareholder in the United States, namely, The Bank of New York
Mellon, our ADS depositary. The number of beneficial owners of our ADSs in the United States is likely to be much larger than the
number of record holders of our ordinary shares in the United States.
None of our shareholders has different voting rights from other shareholders as of the date of this annual report. We are
currently not aware of any arrangement that may, at a subsequent date, result in a change of control of our company.
Item 7.
MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS
A. Major Shareholders
Please refer to “Item 6. Directors, Senior Management and Employees—E. Share Ownership.”
B. Related Party Transactions
Arrangements with Affiliated PRC Entities
Current PRC laws and regulations impose substantial restrictions on foreign ownership of entities involved in ICP, Internet
culture operation and Internet publishing businesses, including online game operations, in China. Therefore, we conduct part of our
activities through a series of agreements with Shanghai IT, our key affiliated PRC entity. Shanghai IT holds the requisite licenses and
approvals for conducting ICP, Internet culture operation and Internet publishing businesses in China. Shanghai IT is owned by our
employee Wei Ji, who acquired his equity interests in Shanghai IT from Jun Zhu in November 2011, and our employee Zhimin Lin,
who acquired his equity interests in Shanghai IT from Yong Wang in April 2014.
We have obtained the exclusive right to benefit from Shanghai IT’s licenses and approvals. In addition, through a series of
contractual arrangements with Shanghai IT and its shareholders, we are able to direct and control the operation and management of
Shanghai IT. We believe that the individual shareholders of Shanghai IT will not receive material personal benefits from these
agreements except as shareholders or employees of The9 Limited.
We do not believe we could have obtained these agreements, taken as a whole, from unrelated third parties. Because of the
uncertainty relating to the legal and regulatory environment in China, the terms of most of the agreements were not defined unless
terminated by the parties thereto. According to our PRC counsel, Zhong Lun Law Firm, subject to the interpretation and
implementation of the GAPP Circular, these agreements, except those that have already been terminated, are valid, binding and
enforceable under the current laws and regulations of China. The principal provisions of these agreements are described below.
Exclusive Technical Service Agreement. We provide Shanghai IT with technical services for the operation of computer
software and related businesses, including the provision of systematic solutions for the operation of Internet websites, the rental of
computer and Internet facilities, daily maintenance of Internet servers and databases, the development and update of relevant
computer software, and all other related technical and consulting services. Shanghai IT pays service fees to us based on their actual
operating results at a service fee equal to 90% of all operating profit generated by Shanghai IT. We are the exclusive provider of these
services to Shanghai IT. According to the relevant PRC rules and regulations, related party transactions should be negotiated at the
arm’s length basis and apply reasonable transfer pricing methods. However, the determination of service fees is under the sole
discretion of us. This agreement does not have specific clauses on renewal but does have an initial term of 20 years (with the earliest
expiration date being December 31, 2029). By virtue of the governance rights we maintain over Shanghai IT, through the terms of the
other agreement noted above, we are able to unilaterally renew, extend or amend the service agreement at our discretion.
Shareholder Voting Proxy Agreement. Each of the shareholders of Shanghai IT has entered into a shareholder voting
proxy agreement with us, under which each shareholder of Shanghai IT irrevocably grants any third parties designate by us the power
to exercise all voting rights to which he/she is entitled as a shareholder of Shanghai IT, including the right to attend shareholders
meetings, to exercise voting rights and to appoint directors, a general manager, and other senior management of Shanghai IT. The
power of proxy is irrevocable and may only be terminated at our discretion.
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Call Option Agreement. We entered into a call option agreement with each of the shareholders of Shanghai IT, under
which the parties irrevocably agreed that, at our sole discretion, we and/or any third parties designated by us will be entitled to
acquire all or part of the equity interests in Shanghai IT, to the extent permitted by the then-effective PRC laws and regulations. The
consideration for such acquisition will be the price equal to the lower of the amount of the registered capital of Shanghai IT and the
minimum amount permissible by the then- applicable PRC law. The shareholders of Shanghai IT have also agreed not to enter into
any transaction, or fail to take any action, that would substantially affect the assets, liabilities, equity, operations or other legal rights
of Shanghai IT without our prior written consent, including, without limitation, declaration and distribution of dividends and profits;
sale, assignment, mortgage or disposition of, or encumbrances on, Shanghai IT’s equity; merger or consolidation; creation,
assumption, guarantee or incurrence of any indebtedness; entering into other materials contracts. This agreement shall not expire until
such time as we acquire all equity interests of Shanghai IT subject to applicable PRC laws.
Loan Agreement. From 2002 to May 2005, we provided an aggregate of RMB23.0 million in loan to the then shareholders
of Shanghai IT, namely Jun Zhu and Yong Wong, for the purposes of capitalizing and increasing the registered capital of Shanghai
IT. Such loan agreement was assumed by the current shareholders of Shanghai IT when Jun Zhu transferred the equity interest in
Shanghai IT to Wei Ji in 2011 and Yong Wang transferred the equity interests in Shanghai IT to Zhimin Lin in 2014. Pursuant to the
terms of this loan agreement, we granted an interest-free loan to each shareholder of Shanghai IT for the explicit purpose of making a
capital contribution to Shanghai IT. The loans have an unspecified term and will remain outstanding for the shorter of the duration of
The9 Computer or that of the Shanghai IT, or until such time that we elect to terminate the agreement (which is at our sole discretion)
at which point the loans are payable on demand. Such loan shall only become immediately due and payable when we send a written
notice to the borrowers requesting repayment. Currently, Zhimin Lin and Wei Ji have pledged all of their equity interests in Shanghai
IT in favor of us under the equity pledge agreements. In the event of a breach of any term in the loan agreement or any other
agreements by either Shanghai IT or its shareholders, we will be entitled to enforce our rights as a pledgee under the agreement.
Equity Pledge Agreements. To secure the full performance by Shanghai IT or its shareholders of their respective
obligations under the Shareholder Voting Proxy Agreement, the Call Option Agreement and the Loan Agreement, the shareholders of
Shanghai IT have pledged all of their equity interests in Shanghai IT in favor of us under two equity pledge agreements. In addition,
the dividend distributions to the shareholders of Shanghai IT, if any, will be deposited in an escrow account over which we have
exclusive control. The pledge shall remain effective until all obligations under such agreements have been fully performed. The
shareholder has the obligation to maintain ownership and effective control over the pledged equity. Under no circumstances, without
our prior written consent, may the shareholder transfer or otherwise encumber any equity interests in Shanghai IT. If any event of
default as provided for therein occurs, The9 Computer, as the pledgee, will be entitled to dispose of the pledged equity interests
through transfer or assignment and use the proceeds to repay the loans or make other payments due under the above loan agreement
up to the loan amounts. Each of the shareholders of Shanghai IT has registered the pledge of its equity interests with the relevant local
administration for industry and commerce pursuant to the new PRC Property Rights Law. In the event of a breach of any term in the
above agreements by either Shanghai IT or its shareholders, we will be entitled to enforce our pledge rights over such pledged equity
interests to compensate for any and all losses suffered from such breach.
Arrangements with Fire Rain and Wanyouyl
Fire Rain. In 2012, we deconsolidated Hangzhou Fire Rain Network Technology Co., Ltd., or Fire Rain, which was
previously our consolidated affiliated entity. As of the date of deconsolidation, we retained a 25% equity interest and contractual
rights to receive repayment of game development expenditures of RMB17 million and a contractual right to receive 20% of the gross
revenues generated by the game. Of the advancement of RMB17.0 million we made to Fire Rain, RMB4.5 million was repaid in
January 2013. In addition, certain cash advances to Fire Rain were secured by the personal guarantee of the spouse of a third-party
shareholder of Fire Rain. In April 2013, we agreed that such shareholder will transfer a 33.5% equity interest in Fire Rain to us and in
return we will release the personal guarantee provided. In March 2014, another shareholder transferred a 4% equity interest in Fire
Rain to us. In June 2015, an individual shareholder transferred his 37.5% equity interest in Fire Rain to us, upon which we started to
hold 100% equity interest in Fire Rain.
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Wanyouyl. In 2012, we deconsolidated Shenzhen Wanyouyinli Technology Co., Ltd., or Wanyouyl, which was previously
our consolidated affiliated entity. We retained a contractual right to receive 20% of future revenues of Era Zero developed by
Wanyouyl, subject to a cap of RMB10 million. In 2013, 2014 and 2015, we received RMB2.6 million, nil and nil, respectively, from
the 20% revenue sharing arrangement for the game developed by Wanyouyl. As of November 9, 2015, Wanyouyl owed Huopu Cloud
RMB4.8 million (US$0.7 million). Pursuant to an assignmeng agreement entered into on December 31, 2015 among Huopu Cloud,
Wanyouyl, Tianwangkongjian and its controlling shareholder Zexiang Zhang, Wanyouyl delegated its obligation to repay the debt of
RMB4.8 million (US$0.7 million) to Tianwangkeji, and the debt shall have a term of five years from January 1, 2016 to December
31, 2020. Zexiang Zhang shall pledge his 20% equity interest in Tianwangkeji to a party designated by us to guarantee his
performance under assignment agreement. On January 4, 2016, we entered into an interest assignment agreement with Huopu Cloud,
pursuant to which Huopu Cloud assigned its aforesaid creditor’s right to us, and an equity pledge agreement with Zexiang Zhang,
pursuant to which he pledged his 20% equity interest in Tianwangkeji to us.
Stock Option Grants
See “Item 6. Directors, Senior Management and Employees—B. Compensation —Share Incentive Plan—Fifth Amended
and Restated 2004 Stock Option Plan.”
Investments or Agreements entered into with Affiliated Entities
In April 2012, we entered into a loan agreement with Beijing Linkage, our related party in which we own 45% equity
interest. Pursuant to the loan agreement, we made a loan in the amount of RMB6.8 million to Beijing Linkage for it to make capital
increase in its invested company. There was RMB5.3 million outstanding balance of such loan as of December 31, 2012. In March
2013, we entered into another loan agreement with Beijing Linkage, pursuant to which we made another loan in the amount of
RMB4.5 million to Beijing Linkage for providing working capital to its invested company. Certain other shareholders of Beijing
Linkage, namely Yong Lv, Qiang Zhang and Linzhen Cheng, have pledged their equity interests in Beijing Linkage for Beijing
Linkage’s obligations under the aforesaid RMB4.5 million working capital loan. Total loan amounted to RMB9.8 million as of
December 31, 2013, and was fully recorded in impairment due to Beijing Linkage’s doubtful ability of repayment, and was fully
impaired in 2013 due to the concern on its recoverability. In November 2014, we sold all of our equity interests in Beijing Linkage to
Qiang Zhang, one of its existing shareholders, for RMB14.0 million cash receipt as consideration. In addition, Beijing Linkage agreed
to repay the total outstanding loan of RMB9.8 million to us. The RMB14 million consideration and part of the loan repayment
RMB5.3 million were received in November 2014. The remaining amount of RMB4.5 million as loan repayment (US$0.7 million)
was received in January 2015.
In February 2013, we established a new joint venture, namely ZTE9, in cooperation with Shanghai Zhongxing
Communication Technology Enterprise Co., Ltd. and Shanghai Ruigao Information Technology Co., Ltd., in Wuxi, Jiangsu province
of China, to develop and operate home entertainment set top box business. In February 2014, Guangdong Hongtu Guangdian
Investment Limited Company made a capital investment of RMB12.5 million to acquire 10% equity interests in ZTE9. As of
December 31, 2015, we held 30.2% equity interest in ZTE9. For the year ended December 31, 2013, 2014 and 2015, net royalty
charged by ZTE9 for providing game contents on IPTV to us was RMB6.0 million and RMB6.8 million and RMB6.3 million
(US$1.0 million), respectively. As of December 31, 2015, the outstanding balance due to ZTE9 was RMB6.0 million (US$0.9
million). In 2015, we extended a loan of RMB9.9 million (US$1.5 million) to ZTE9 to fund its operations, all of which remained
outstanding as of December 31, 2015. The loan was interest-free and will be due from March to August 2016.
C.
Interests of Experts and Counsel
Not applicable.
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Item 8.
FINANCIAL INFORMATION
A. Consolidated Statements and Other Financial Information
We have appended consolidated financial statements filed as part of this annual report.
Legal Proceedings
In May 2011, Diego Maradona, a former Argentina soccer star, filed a lawsuit in the Beijing No. 1 Intermediate People’s
Court against Shanghai IT and a third-party company in China, alleging that the defendants used his name and image in a web and
social game operated by us without his authorization. In July 2011, the plaintiff amended his complaint to include The9 Computer as
a defendant. The plaintiff in the case demanded, among others, that the defendants pay RMB20 million for his alleged losses. In June
2013, the Beijing No.1 People’s Intermediate Court issued a judgment against us for infringing the portraiture right of the plaintiff
and required us to pay a total of RMB3 million as economic damages and other related fees to the plaintiff. We have appealed the
case to the Beijing People’s Superior Court. A hearing was held by the court on December 26, 2013 and the court made a decision
rejecting our appeal on April 10, 2014. We made a petition to the Supreme Court and the Supreme Court accepted our petition on
July 14, 2014. The Supreme Court made a decision upholding the Beijing No. 1 Intermediate People’s Court decision on December
16, 2014. According to the judgment, we shall pay to the plaintiff an aggregate amount of RMB3 million (US$0.5 million) and any
accrued interests thereof for late payment. In February 2015, we entered into a settlement agreement with the plaintiff to pay a total of
RMB3.3 million (US$0.5 million) to settle the matter.
On December 30, 2014, Shanghai Anjiu Network Information Limited, or Shanghai Anjiu, filed a lawsuit in Shanghai
Pudong People’s Court against Shanghai IT, claiming us for an advertisement fee of approximately RMB1.5 million and a penalty of
RMB82,000. Shanghai IT and Shanghai Anjiu settled this case for paying a total of RMB1.4 million (US$0.2 million) to the plaintiff
in January 2015.
On September 30, 2015, a former employee who served as a human resources generalist of Red 5 filed a complaint before
the Superior Court of California, County of Orange, against Red 5 and our company for wrongful termination of employment, and
claimed general damages in excess of US$1.0 million and special damages in excess of US$0.5 million. On February 22, 2016, we
submitted an answer to complaint and demand to the court to defend the action. We believe that such proceeding, when finally
resolved, is unlikely to have a material adverse effect on our results of operations, financial position and cash flows.
Other than the foregoing, we are not currently a party to any material litigation or other legal proceeding and are not aware
of any pending or threatened litigation or other legal proceeding that may have a material adverse impact on our business, financial
condition and results of operations.
Dividend Policy
We currently intend to retain most, if not all, of our available funds and any future earnings for use in the operation and
expansion of our business. Our board of directors has discretion as to whether we will distribute dividends in the future, subject to
applicable laws. Even if our board of directors determines to distribute dividends, the form, frequency and amount of our dividends
will depend upon our future operations and earnings, capital requirements and surplus, general financial condition, contractual
restrictions, legal restrictions and other factors as the board of directors may deem relevant. Any dividend we declare will be paid to
the holders of ADSs, subject to the terms of the deposit agreement, to the same extent as holders of our ordinary shares, less the fees
and expenses payable under the deposit agreement. Any dividend we declare will be distributed by the depositary bank to the holders
of our ADSs. Cash dividends on our ordinary shares, if any, will be paid in U.S. dollars.
B.
Significant Changes
Except as otherwise disclosed in this annual report, we have not experienced any significant changes since the date of our
audited consolidated financial statements included in this annual report.
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Item 9.
THE OFFER AND LISTING
A. Offer and Listing Details
Our ADSs, each representing one ordinary share, have been listed on the Nasdaq Global Market since December 15, 2004.
Our ADSs are traded under the symbol “NCTY.” The following table provides the high and low trading prices for our ADSs on the
Nasdaq Global Market for the periods specified.
Annual High and Low
2011
2012
2013
2014
2015
Quarterly High and Low
First Quarter 2014
Second Quarter 2014
Third Quarter 2014
Fourth Quarter 2014
First Quarter 2015
Second Quarter 2015
Third Quarter 2015
Fourth Quarter 2015
First Quarter 2016
Monthly High and Low
October 2015
November 2015
December 2015
January 2016
February 2016
March 2016
April 2016 (through April 8, 2016)
B.
Plan of Distribution
Not applicable.
C. Markets
Sales Price
High Low
8.49
7.98
4.50
4.22
4.49
2.90
2.71
2.08
1.52
0.90
3.20
2.83
4.22
2.51
1.71
2.14
1.66
4.49
3.28
1.49
4.49
4.40
3.14
3.28
2.72
2.55
2.09
2.10
2.27
1.52
1.09
1.21
1.09
0.90
1.81
0.90
1.31
2.84
2.00
1.81
2.11
2.23
Our ADSs, each representing one ordinary share, have been listed on the Nasdaq Global Market since December 15, 2004
under the symbol “NCTY.”
D.
Selling Shareholders
Not applicable.
E. Dilution
Not applicable.
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F. Expenses of the Issue
Not applicable.
Item 10.
ADDITIONAL INFORMATION
A.
Share Capital
Not applicable.
B. Memorandum and Articles of Association
We are an exempted company incorporated in the Cayman Islands and our affairs are governed by our memorandum and
articles of association and the Companies Law (2013 Revision) of the Cayman Islands, which is referred to as the Companies Law
below.
As of the date of this annual report, our authorized share capital is US$2,500,000, consisting of 250,000,000 ordinary
shares, par value of US$0.01 each. The following are summaries of material provisions of our currently effective amended and
restated memorandum and articles of association and the Companies Law insofar as they relate to the material terms of our ordinary
shares.
Ordinary Shares
General. All of our outstanding ordinary shares are fully paid and non-assessable. Certificates representing the ordinary
shares are issued in registered form. Our shareholders may freely hold and vote their shares.
Dividends. The holders of our ordinary shares are entitled to such dividends as may be declared by our board of directors
subject to the Companies Law.
Voting Rights. Each ordinary share is entitled to one vote on all matters upon which the ordinary shares are entitled to
vote. Voting at any meeting of shareholders is by show of hands unless a poll is demanded. A poll may be demanded by any
shareholder or shareholders together holding at least ten percent of the shares given a right to vote at the meeting, present in person or
by proxy.
A quorum required for a meeting of shareholders consists of holders of not less than one-third of all outstanding shares
entitled to vote. Shareholders’ meetings shall, if required by the Companies Law, be held annually. Annual general meetings and
extraordinary general meetings may be convened by our board of directors on its own initiative. Extraordinary general meetings shall
be convened by our board of directors upon a request to the directors by shareholders holding in aggregate at least 33% of our voting
share capital. Advance notice of at least seven business days is required for the convening of our annual general meeting and other
shareholders meetings.
An ordinary resolution to be passed by the shareholders requires the affirmative vote of a simple majority of the votes
attaching to the ordinary shares cast in a general meeting, while a special resolution requires the affirmative vote of no less than two-
thirds of the votes attaching to the ordinary shares cast in a general meeting and includes a unanimous written resolution expressly
passed as a special resolution. A special resolution is required for important matters such as a change of name, a decrease of our share
capital, or amending the memorandum and articles of association. Holders of the ordinary shares may effect certain changes by
ordinary resolution, including an increase of our share capital, the consolidation and division of all or any of our share capital into
shares of a larger amount than our existing share capital, and the cancellation of any shares.
Transfer of Shares. Subject to the restrictions of our articles of association, as applicable, any of our shareholders may
transfer all or any of his or her ordinary shares by an instrument of transfer in the usual or common form or any other form approved
by our board. The transferor shall be deemed to remain the holder of the shares until the name of the transferee is entered in the
register of members in respect thereof.
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Liquidation. On a return of capital on winding up or otherwise (other than on conversion, redemption or purchase of
shares), assets available for distribution among the holders of ordinary shares shall be distributed among the holders of the ordinary
shares as the liquidator deems fair. If our assets available for distribution are insufficient to repay all of the paid-up capital, the assets
will be distributed so that the losses are borne by our shareholders proportionately.
Calls on Shares and Forfeiture of Shares. Our board of directors may from time to time make calls upon shareholders for
any amounts unpaid on their shares in a notice served to such shareholders at least 14 days prior to the specified time and place of
payment. The shares that have been called upon and remain unpaid on the specified time are subject to forfeiture.
Redemption and Repurchase of Shares. Subject to the provisions of the Companies Law and our articles of association,
we may issue shares on terms that are subject to redemption, at our option or at the option of the holders, on such terms and in such
manner as may be determined by our board of directors. Our company may also repurchase any of our shares provided that the
manner of such purchase has been approved by ordinary resolution of our shareholders or the manner of such purchase is in
accordance with our articles of association. Under the Companies Law, the redemption or repurchase of any share may be paid out of
our company’s profits or out of the proceeds of a fresh issue of shares made for the purpose of such redemption or repurchase, or out
of capital (including share premium account and capital redemption reserve) if the company can, immediately following such
payment, pay its debts as they fall due in the ordinary course of business. In addition, under the Companies Law no such share may
be redeemed or repurchased (a) unless it is fully paid up, (b) if such redemption or repurchase would result in there being no shares
outstanding, or (c) if the company has commenced liquidation.
Variation of Rights of Shares. All or any of the special rights attached to any class of shares may, subject to the provisions
of the Companies Law, be varied either with the written consent of a majority of the issued shares of that class or with the sanction of
an ordinary resolution passed at a general meeting of the holders of the shares of that class.
Inspection of Books and Records. Holders of our ordinary shares will have no general right under Cayman Islands law to
inspect or obtain copies of our list of shareholders or our corporate records. However, we will provide our shareholders with annual
audited financial statements. See “— H. Documents on Display.”
Differences in Corporate Law
The Companies Law is modeled after that of English law but does not follow recent English law statutory enactments. In
addition, the Companies Law differs from laws applicable to Delaware corporations and their shareholders. Set forth below is a
summary of the significant differences between the provisions of the Companies Law applicable to us and the laws applicable to
Delaware corporations and their shareholders.
Mergers and Similar Arrangements. The Companies Law permits mergers and consolidations between Cayman Islands
companies and between Cayman Islands companies and non-Cayman Islands companies. For these purposes:
•
•
a “merger” means the merging of two or more constituent companies and the vesting of their undertaking, property
and liabilities in one of such companies as the surviving company; and
a “consolidation” means the combination of two or more constituent companies into a consolidated company and
the vesting of the undertaking, property and liabilities of such companies to the consolidated company.
In order to effect such a merger or consolidation, the directors of each constituent company must approve a written plan of
merger or consolidation, which must then be authorized by:
•
•
a special resolution of the shareholders of each constituent company; and
such other authorizations, if any, as may be specified in such constituent company’s articles of association.
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The plan of merger or consolidation must be filed with the Registrar of Companies together with a declaration as to the
solvency of the consolidated or surviving company, a declaration as to the assets and liabilities of each constituent company and an
undertaking that a copy of the certificate of merger or consolidation will be given to the members and creditors of each constituent
company that notification of the merger or consolidation will be published in the Cayman Islands Gazette. Dissenting shareholders
have the right to be paid the fair value of their shares if they follow the required procedures, subject to certain exceptions. The fair
value of the shares will be determined by the Cayman Islands court if it cannot be agreed among the parties. Court approval is not
required for a merger or consolidation which is effected in compliance with these statutory procedures.
In addition, there are statutory provisions that facilitate the reconstruction and amalgamation of companies, provided that
the arrangement is approved by a majority in number of each class of shareholders or creditors with whom the arrangement is to be
made, and who must in addition represent three-fourths in value of each such class of shareholders or creditors, as the case may be,
that are present and voting either in person or by proxy at a meeting, or meetings, convened for that purpose. The convening of the
meetings and subsequently the arrangement must be sanctioned by the Grand Court of the Cayman Islands. While a dissenting
shareholder has the right to express to the court the view that the transaction ought not to be approved, the court can be expected to
approve the arrangement if it determines that:
•
•
•
•
the statutory provisions as to majority vote have been met;
the shareholders have been fairly represented at the meeting in question and the statutory majority are acting bona
fide without coercion of the minority to promote interests adverse to those of the class;
the arrangement is such that may be reasonably approved by an intelligent and honest man of that class acting in
respect of his interest; and
the arrangement is not one that would more properly be sanctioned under some other provision of the Companies
Law.
When a take-over offer is made and accepted by holders of 90% of the shares affected within four months, the offeror may,
within a two month period commencing on the expiration of such four month period, require the holders of the remaining shares to
transfer such shares on the terms of the offer. An objection can be made to the Grand Court of the Cayman Islands but this is unlikely
to succeed in the case of an offer which has been so approved unless there is evidence of fraud, bad faith or collusion.
If the arrangement and reconstruction is thus approved, the dissenting shareholder would have no rights comparable to
appraisal rights, which would otherwise ordinarily be available to dissenting shareholders of Delaware corporations, providing rights
to receive payment in cash for the judicially determined value of the shares.
Shareholders’ Suits. The Cayman Islands courts can be expected to follow English case law precedents. The Cayman
Islands courts can be expected to apply and follow common law principles (namely the rule in Foss v Harbottle and the exceptions
thereto) that permit a minority shareholder to commence a class action against the company or a derivative action in the name of the
company to challenge (1) an act that is outside the company’s corporate powers or that is illegal, (2) an act constituting a fraud
against the minority shareholders where the wrongdoers are themselves in control of the company, and (3) an action requiring a
resolution passed by a qualified or special majority that has not been obtained.
Directors’ Fiduciary Duties. Under Delaware corporate law, a director of a Delaware corporation has a fiduciary duty to
the corporation and its shareholders. This duty has two components: the duty of care and the duty of loyalty. The duty of care requires
that a director act in good faith, with the care that an ordinarily prudent person would exercise under similar circumstances. Under
this duty, a director must inform himself of, and disclose to shareholders, all material information reasonably available regarding a
significant transaction. The duty of loyalty requires that a director act in a manner he reasonably believes to be in the best interests of
the corporation, he must not use his corporate position for personal gain or advantage. This duty prohibits self-dealing by a director
and mandates that the best interest of the corporation and its shareholders take precedence over any interest possessed by a director,
officer or controlling shareholder and not shared by the shareholders generally. In general, actions of a director are presumed to have
been made on an informed basis, in good faith and in the honest belief that the action taken was in the best interests of the
corporation. However, this presumption may be rebutted by evidence of a breach of one of the fiduciary duties. Should such evidence
be presented concerning a transaction by a director, a director must prove the procedural fairness of the transaction, and that the
transaction was of fair value to the corporation.
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As a matter of Cayman Islands law, a director of a Cayman Islands company is in the position of a fiduciary with respect to
the company and therefore it is considered that he owes the following duties to the company — a duty to act in good faith in the best
interests of the company, a duty not to make a personal profit out of his position as director (unless the company permits him to do
so), a duty not to put himself in a position where the interests of the company conflict with his personal interest or his duty to a third
party and a duty to exercise powers for the purpose for which such powers were intended. A director of a Cayman Islands company
owes to the company a duty to act with skill and care. It was previously considered that a director need not exhibit in the performance
of his duties a greater degree of skill than may reasonably be expected from a person of his knowledge and experience. However,
there are indications that the English and Commonwealth courts are moving towards an objective standard with regard to the required
skill and care and these authorities are likely to be followed in the Cayman Islands.
Shareholder Action by Written Consent. Under the Delaware General Corporation Law, a corporation may eliminate the
right of shareholders to act by written consent by amendment to its certificate of incorporation. Cayman Islands law and our articles
of association provide that shareholders may approve corporate matters by way of written resolution signed by or on behalf of each
shareholder who would have been entitled to vote on such matter at a general meeting without a meeting being held.
Shareholder Proposals. Under the Delaware General Corporation Law, a shareholder has the right to put any proposal
before the annual meeting of shareholders, provided it complies with the notice provisions in the governing documents. A special
meeting may be called by the board of directors or any other person authorized to do so in the governing documents, but shareholders
may be precluded from calling special meetings. Cayman Islands law and our articles of association allow our shareholders holding
not less than 33 per cent of the paid up voting share capital of our company to requisition a shareholder’s meeting.
Cumulative Voting. Under the Delaware General Corporation Law, cumulative voting for elections of directors is not
permitted unless the corporation’s certificate of incorporation specifically provides for it. Cumulative voting potentially facilitates the
representation of minority shareholders on a board of directors since it permits the minority shareholder to cast all the votes to which
the shareholder is entitled on a single director, which increases the shareholder’s voting power with respect to electing such director.
As permitted under Cayman Islands law, our articles of association do not provide for cumulative voting.
Removal of Directors. Under the Delaware General Corporation Law, a director of a corporation may be removed with the
approval of a majority of the outstanding shares entitled to vote, unless the certificate of incorporation provides otherwise. Under our
articles of association, directors can be removed with or without cause, but only by the vote of a majority of the holders of our shares
voting at a general meeting or the unanimous written resolution of all shareholders.
Transactions with Interested Shareholders. The Delaware General Corporation Law contains a business combination
statute applicable to Delaware public corporations whereby, unless the corporation has specifically elected not to be governed by such
statute by amendment to its certificate of incorporation, it is prohibited from engaging in certain business combinations with an
“interested shareholder” for three years following the date that such person becomes an interested shareholder. An interested
shareholder generally is a person or group who or which owns or owned 15% or more of the target’s outstanding voting stock within
the past three years. This has the effect of limiting the ability of a potential acquiror to make a two-tiered bid for the target in which
all shareholders would not be treated equally. The statute does not apply if, among other things, prior to the date on which such
shareholder becomes an interested shareholder, the board of directors approves either the business combination or the transaction
which resulted in the person becoming an interested shareholder. This encourages any potential acquiror of a Delaware public
corporation to negotiate the terms of any acquisition transaction with the target’s board of directors.
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Cayman Islands law has no comparable statute. As a result, we cannot avail ourselves of the types of protections afforded
by the Delaware business combination statute. However, although Cayman Islands law does not regulate transactions between a
company and its significant shareholders, it does provide that such transactions must be entered into bona fide in the best interests of
the company and for a proper purpose and not with the effect of constituting a fraud on the minority shareholders.
Dissolution; Winding Up. Under the Delaware General Corporation Law, unless the board of directors approves the
proposal to dissolve, dissolution must be approved by shareholders holding 100% of the total voting power of the corporation. Only if
the dissolution is initiated by the board of directors may it be approved by a simple majority of the corporation’s outstanding shares.
Delaware law allows a Delaware corporation to include in its certificate of incorporation a supermajority voting requirement in
connection with dissolutions initiated by the board. Under the Companies Law, our company may be dissolved, liquidated or wound
up by either an order of the courts of the Cayman Islands or by a special resolution, or by an ordinary resolution on the basis that our
company is unable to pay its debts as they fall due. The court has authority to order winding up in a number of specified
circumstances including where it is, in the opinion of the court, just and equitable to do so.
Variation of Rights of Shares. Under the Delaware General Corporation Law, a corporation may vary the rights of a class
of shares with the approval of a majority of the outstanding shares of such class, unless the certificate of incorporation provides
otherwise. Under our articles of association, if our share capital is divided into more than one class of shares, we may vary the rights
attached to any class only with the written consent of the holders of at least a majority of the shares of such class or with the sanction
of a resolution passed by at least a majority of the holders of such class present in person or by proxy at a separate general meeting of
the holders of the shares of that class.
Amendment of Governing Documents. Under the Delaware General Corporation Law, a corporation’s governing
documents may be amended with the approval of a majority of the outstanding shares entitled to vote, unless the certificate of
incorporation provides otherwise. As permitted by Cayman Islands law, our memorandum and articles of association may be
amended with the vote of at least two-third holders of our shares at a general meeting or the unanimous written resolution of all
shareholders.
Anti-Takeover Provisions in Memorandum and Articles of Association. Some provisions of our memorandum and
articles of association may discourage, delay or prevent a change in control of our company or management that shareholders may
consider favorable, including provisions that:
•
•
authorize our board of directors to issue preference shares in one or more series and to designate the price, rights,
preferences, privileges and restrictions of such preference shares without any further vote or action by our
shareholders; and
create a classified board of directors pursuant to which our directors are elected for staggered terms, which means
that shareholders can only elect, or remove, a limited number of directors in any given year.
However, under Cayman Islands law, our directors may only exercise the rights and powers granted to them under our
memorandum and articles of association for a proper purpose and for what they believe in good faith to be in the best interests of our
company.
Rights of Non-Resident or Foreign Shareholders. There are no limitations imposed by our memorandum and articles of
association on the rights of non-resident or foreign shareholders to hold or exercise voting rights on our shares. In addition, there are
no provisions in our memorandum and articles of association governing the ownership threshold above which shareholder ownership
must be disclosed.
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Inspection of Books and Records. Under the Delaware General Corporation Law, any shareholder of a corporation may
for any proper purpose inspect or make copies of the corporation’s stock ledger, list of shareholders and other books and records.
Holders of our shares will have no general right under Cayman Islands law to inspect or obtain copies of our list of shareholders or
corporate records. However, we will provide our shareholders with annual audited financial statements.
Shareholder Rights Plan
On January 8, 2009, our board of directors declared a dividend of one ordinary share purchase right, or a Right, for each of
our ordinary shares outstanding at the close of business on January 22, 2009. See “Item 14. Material Modifications to the Rights of
Security Holders and Use of Proceeds.”
C. Material Contracts
We have not entered into any material contracts other than in the ordinary course of business and other than those
described in “Item 4. Information on the Company” or elsewhere in this annual report.
D. Exchange Controls
See “Item 4. Information on the Company—B. Business Overview—Government Regulations—Regulations on Foreign
Currency Exchange and Dividend Distribution.”
E. Taxation
Cayman Islands Taxation
In the opinion of our Cayman Islands counsel, Maples and Calder, the Cayman Islands currently levies no taxes on
individuals or corporations based upon profits, income, gains or appreciation and there is no taxation in the nature of inheritance tax
or estate duty. No Cayman Islands stamp duty will be payable unless an instrument is executed in, or after execution, brought to, or
produced before a court of the Cayman Islands. The Cayman Islands is not party to any double tax treaties which are applicable to
payments made to or by our company. There are no exchange control regulations or currency restrictions in the Cayman Islands.
People’s Republic of China Taxation
If we are considered a PRC resident enterprise under the EIT Law, our shareholders and ADS holders who are deemed
non-resident enterprises may be subject to the 10% EIT on the dividends payable by us or any gains realized from the transfer of our
shares or ADSs, if such income is deemed derived from China, provided that (i) such foreign enterprise investor has no establishment
or premises in China, or (ii) it has establishment or premises in China but its income derived from China has no real connection with
such establishment or premises. Furthermore, if we are considered a PRC resident enterprise and relevant PRC tax authorities
consider the dividends we pay with respect to our shares or ADSs and the gains realized from the transfer of our shares or ADSs to be
income derived from sources within the PRC, it is also possible that such dividends and gains earned by non-resident individuals may
be subject to the 20% PRC individual income tax. It is uncertain whether, if we are considered a PRC resident enterprise, holders of
our shares or ADSs would be able to claim the benefit of tax treaties or arrangements entered into between China and other
jurisdictions.
If we are required under the PRC tax law to withhold PRC income tax on our dividends payable to our non-PRC resident
shareholders and ADS holders, or if any gains realized from the transfer of our shares or ADSs by our non-PRC resident shareholders
and ADS holders are subject to the EIT or the individual income tax, your investment in our shares or ADSs could be materially and
adversely affected.
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U. S. Federal Income Taxation
The following discussion is a summary of U.S. federal income tax considerations to U.S. Holders (as defined below)
relating to the ownership and disposition of the ADSs or ordinary shares. This discussion applies only to U.S. Holders of the ADSs or
ordinary shares as “capital assets” (generally, property held for investment). This discussion is based on the tax laws of the United
States in effect as of the date of this annual report and on U.S. Treasury regulations in effect or, in some cases, proposed as of the date
of this annual report, as well as judicial and administrative interpretations thereof available on or before such date. All of the
foregoing authorities are subject to change, which change could apply retroactively and could affect the tax consequences described
below.
The following discussion is for general information only and does not address all of the tax considerations that may be
relevant to any particular investor or to persons in special tax situations such as:
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
banks and other financial institutions;
insurance companies;
pension plans;
cooperatives;
regulated investment companies;
real estate investment trusts;
broker-dealers;
traders that elect to use a mark-to-market method of accounting;
U.S. expatriates or entities subject to the U.S. anti-inversion rules;
tax-exempt entities (including private foundations);
persons liable for alternative minimum tax;
persons whose functional currency is not the U.S. dollar;
persons holding ADSs or ordinary shares as part of a straddle, hedging, conversion or integrated transaction for U.S.
federal income tax purposes;
persons holding ADSs or ordinary shares through a bank, financial institution or other entity, or a branch thereof,
located, organized or resident outside the United States;
persons that directly, indirectly or constructively own 10% or more of the total combined voting power of all classes
of our voting stock;
partnerships or other pass-through entities, or persons holding ADSs or ordinary shares through such entities; or
persons who acquired ADSs or ordinary shares pursuant to the exercise of any employee share option or otherwise
as compensation.
In addition, the discussion below does not address any U.S. state, local or non-U.S. tax considerations, the Medicare tax,
alternative minimum tax, or any non-income tax (such as U.S. federal estate or gift tax) considerations.
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U.S. HOLDERS ARE URGED TO CONSULT THEIR TAX ADVISORS REGARDING THE APPLICATION OF THE U.S.
FEDERAL TAX RULES TO THEIR PARTICULAR CIRCUMSTANCES AS WELL AS THE STATE, LOCAL, NON-U.S.
AND OTHER TAX CONSEQUENCES TO THEM OF THE PURCHASE, OWNERSHIP AND DISPOSITION OF ADSs OR
ORDINARY SHARES.
The discussion below of the U.S. federal income tax consequences to “U.S. Holders” will apply to you if you are a
beneficial owner of ADSs or ordinary shares and you are, for U.S. federal income tax purposes:
•
•
•
•
an individual who is a citizen or resident of the United States;
a corporation (or other entity taxable as a corporation for U.S. federal income tax purposes) organized under the
laws of the United States, any state thereof or the District of Columbia;
an estate, the income of which is subject to U.S. federal income taxation regardless of its source; or
a trust that (1) is subject to the primary supervision of a court within the United States and the control of one or
more U.S. persons for all substantial decisions or (2) has a valid election in effect under applicable U.S. Treasury
regulations to be treated as a U.S. person.
If a partnership (or other entity taxable as a partnership for U.S. federal income tax purposes) is a beneficial owner of our
ADSs or ordinary shares, the tax treatment of a partner in such partnership will depend on the status of such partner and the activities
of such partnership. If you are a partner or a partnership holding our ADSs or ordinary shares, you are urged to consult your tax
advisor as to the particular U.S. federal income tax considerations of an investment in the ADSs or ordinary shares that is applicable
to you.
It is generally expected that a holder of ADSs should be treated, for U.S. federal income tax purposes, as the beneficial
owner of the underlying shares represented by the ADSs. The remainder of this discussion assumes that a holder of ADSs will be
treated in this manner. Predicated upon such treatment, deposits or withdrawals of our ordinary shares for our ADSs will not be
subject to U.S. federal income tax. The U.S. Treasury has expressed concerns that intermediaries in the chain of ownership between
the holder of an ADS and the issuer of the security underlying the ADS may be taking actions that are inconsistent with the beneficial
ownership of the underlying security (for example, pre-releasing ADSs to persons that do not have beneficial ownership of the
securities underlying the ADSs). Accordingly, the creditability of any foreign tax credits or the availability of the reduced tax rate for
dividends received by certain non-corporate U.S. Holders, including individual U.S. Holders (as discussed below), could be affected
by actions taken by intermediaries in the chain of ownership between the holders of ADSs and our company if as a result of such
actions the holders of ADSs are not properly treated as beneficial owners of underlying ordinary shares.
Passive Foreign Investment Company
Based on the market price of our ADSs and the value and composition of our assets and liabilities, we believe we were not
a passive foreign investment company (“PFIC”) for U.S. federal income tax purposes for the taxable year ended December 31, 2015.
However, as previously disclosed, although not free from doubt, we believed that we were a PFIC for U.S. federal income tax
purposes for prior years.
A non-U.S. corporation will be a PFIC for any taxable year if either:
•
•
at least 75% of its gross income for such year consists of certain types of passive income (the “income test”); or
at least 50% of the average quarterly value of its assets (as generally determined on the basis of fair market value)
produce or are held for the production of passive income (the “asset test”).
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For this purpose, cash and assets readily convertible into cash are generally classified as passive assets and goodwill and
other unbooked intangibles associated with active business activities may generally be classified as non-passive assets. Passive
income generally includes dividends, interest, royalties and rents (other than certain royalties and rents derived in the active conduct
of a trade or business and not derived from a related person), and gains from the disposition of passive assets. The classification of
certain of our income as active or passive and certain of our assets as producing active or passive income, and hence whether we
expect to be or will become a PFIC, depends on the interpretation of certain U.S. Treasury Regulations, including certain regulations
relating to royalty income and income from intangible assets, as well as certain Internal Revenue Service (“IRS”) guidance relating to
the classification of assets as producing active or passive income and certain IRS guidance relating to the distinction between services
income and royalties for U.S. federal income tax purposes. Such regulations and guidance are potentially subject to different
interpretations. If the percentage of our passive income or our assets treated as producing passive income increases, we may be more
likely to be treated as a PFIC for such taxable year.
We will be treated as owning our proportionate share of the assets and earning our proportionate share of the income of
any other corporation in which we own, directly or indirectly, at least 25% (by value) of the stock. In applying this rule, however, it is
not clear whether the contractual arrangements between us and our affiliated entities will be treated as ownership of stock. Moreover,
it is not clear whether gain recognized from the sale of stock (or an arrangement treated as ownership of stock for U.S. federal income
tax purposes) in a 25% (by value) or greater owned subsidiary (or VIE) is characterized as passive or as if we had held and sold
directly our proportionate share of our subsidiary’s (or VIE’s) assets.
Although the law in this regard is not clear, we treat our VIEs as being owned by us for U.S. federal income tax purposes
because we exercise effective control over them and are entitled to substantially all of their economic benefits. As a result, we
consolidate the VIEs’ results of operations in our consolidated U.S. GAAP financial statements. If it were determined that we are not
the owner of our VIEs for U.S. federal income tax purposes, the composition of our income and assets would change and we may be
more likely to be treated as a PFIC for any subsequent taxable year.
We must make a separate determination after the close of each taxable year as to whether we were a PFIC for that year.
Because the value of our assets for purposes of the asset test generally will be determined by reference to the market price of our
ADSs or ordinary shares from time to time, our PFIC status will depend in part on the market price of our ADSs or ordinary shares,
which may fluctuate significantly, and the composition of our assets and liabilities. Based on the market price of our ADSs and the
value and composition of our assets and liabilities, we believe that we were not a PFIC for U.S. federal income tax purposes for the
taxable year ended December 31, 2015. However, as previously disclosed, although not free from doubt, we believed that we were a
PFIC for U.S. federal income tax purposes for prior years.
If we are a PFIC for any taxable year during which you hold ADSs or ordinary shares, we generally will continue to be
treated as a PFIC with respect to you for all succeeding years during which you hold ADSs or ordinary shares. However, if we cease
to be a PFIC, provided that you have not made a mark-to-market election, as described below, you may avoid some of the adverse
effects of the PFIC regime by making a “deemed sale” election with respect to the ADSs or ordinary shares, as applicable. If such
election is made, you will be deemed to have sold our ADSs or ordinary shares you hold at their fair market value and any gain from
such deemed sale would be subject to the rules described in the following two paragraphs. After the deemed sale election, so long as
we do not become a PFIC in a subsequent taxable year, your ADSs or ordinary shares with respect to which such election was made
will not be treated as shares in a PFIC and you will not be subject to the rules described below with respect to any “excess
distribution” you receive from us or any gain from an actual sale or other disposition of the ADSs or ordinary shares. The rules
dealing with deemed sale elections are very complex. You are strongly urged to consult your tax advisors as to the possibility
and consequences of making a deemed sale election if we cease to be a PFIC and such election becomes available to you.
For each taxable year that we are treated as a PFIC with respect to you, you will be subject to special tax rules with respect
to any “excess distribution” you receive and any gain you recognize from a sale or other disposition (including a pledge) of the ADSs
or ordinary shares, unless you make a “mark-to-market” election as discussed below. Distributions you receive in a taxable year that
are greater than 125% of the average annual distributions you received during the shorter of the three preceding taxable years or your
holding period for the ADSs or ordinary shares will be treated as an excess distribution. Under these special tax rules, if you receive
any excess distribution or recognize any gain from a sale or other disposition of the ADSs or ordinary shares:
•
the excess distribution or recognized gain will be allocated ratably over your holding period for the ADSs or
ordinary shares;
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•
•
•
the amount allocated to the current taxable year, and any taxable years in your holding period prior to the first
taxable year in which we became a PFIC (a “pre-PFIC year”), will be treated as ordinary income;
the amount allocated to each prior taxable year, other than a pre-PFIC year, will be subject to the highest tax rate in
effect for individuals or corporations, as applicable, for each such year; and
the interest charge generally applicable to underpayments of tax will be imposed on the resulting tax attributable to
each prior taxable year other than a pre-PFIC year.
The tax liability for amounts allocated to years prior to the year of disposition or excess distribution cannot be offset by
any net operating losses for such years, and gains (but not losses) from the sale or other disposition of the ADSs or ordinary shares
cannot be treated as capital, even if you hold the ADSs or ordinary shares as capital assets.
If we are a PFIC for any taxable year and any of non-U.S. subsidiaries is also a PFIC, a U.S. Holder would be treated as
owning a proportionate amount (by value) of the shares of the lower-tier PFIC for purposes of the application of these rules, and
could incur liability for the deferred tax and interest charge described below if either (1) we receive a distribution from, or dispose of
all or part of our interest in, the lower-tier PFICs or (2) you dispose of all or part of your ADSs or ordinary shares. It is possible that
one or more of our subsidiaries were PFICs for the taxable year ending December 31, 2015. You should consult your tax advisors
regarding the application of the PFIC rules to any of our subsidiaries.
The tax liability for amounts allocated to years prior to the year of disposition of “excessive distribution” cannot be offset
by any net operating losses for such years, and gains (but not losses) realized on the sale of the ADSs or ordinary shares cannot be
treated as capital, even if you hold the ADSs or ordinary shares as capital assets.
Alternatively, a U.S. Holder of “marketable stock” (as defined below) of a PFIC may make a mark-to-market election for
such stock to elect out of the PFIC rules described above regarding excess distributions and recognized gains. If you make a valid
mark-to-market election for the ADSs or ordinary shares, you will include in income for each year that we are a PFIC an amount
equal to the excess, if any, of the fair market value of the ADSs or ordinary shares as of the close of your taxable year over your
adjusted basis in such ADSs or ordinary shares. You will be allowed a deduction for the excess, if any, of the adjusted basis of the
ADSs or ordinary shares over their fair market value as of the close of the taxable year. However, deductions will be allowable only
to the extent of any net mark-to-market gains on the ADSs or ordinary shares included in your income for prior taxable years.
Amounts included in your income under a mark-to-market election, as well as gain on the actual sale or other disposition of the ADSs
or ordinary shares, will be treated as ordinary income. Ordinary loss treatment will apply to the deductible portion of any mark-to-
market loss on the ADSs or ordinary shares, as well as to any loss from the actual sale or other disposition of the ADSs or ordinary
shares, to the extent that the amount of such loss does not exceed the net mark-to-market gains previously included for such ADSs or
ordinary shares. Your basis in the ADSs or ordinary shares will be adjusted to reflect any such income or loss amounts. If you make a
mark-to-market election, any distributions that we make generally would be subject to the tax rules discussed below under “—
Taxation of Dividends and Other Distributions on the ADSs or Ordinary Shares,” except that the lower tax rate applicable to qualified
dividend income would not apply.
The mark-to-market election is available only for “marketable stock,” which is stock that is traded in greater than de
minimis quantities on at least 15 days during each calendar quarter (“regularly traded”) on a qualified exchange or other market, as
defined in applicable U.S. Treasury regulations. Although our ADSs are currently listed on Nasdaq, which is a qualified exchange or
other market for these purposes, no assurance can be given that the ADSs will be regularly traded on an established securities market
in the United States for any taxable year. If any of our subsidiaries are or become PFICs, the mark-to-market election will likely not
be available with respect to the shares of such subsidiaries that are treated as owned by you. Consequently, you could be subject to
the PFIC rules with respect to income of the lower-tier PFICs the value of which already had been taken into account indirectly via
mark-to-market adjustments. You should consult your tax advisors as to the availability and desirability of a mark-to-market election,
as well as the impact of such election on interests in any lower-tier PFICs.
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Alternatively, a U.S. Holder of stock in a PFIC may make a “qualified electing fund” election with respect to such
corporation to elect out of the PFIC rules described above regarding excess distributions and recognized gains. A U.S. Holder that
makes a qualified electing fund election with respect to a PFIC generally will include in income such holder’s pro rata share of the
corporation’s income on a current basis. However, you may make a qualified electing fund election with respect to your ADSs or
ordinary shares only if we furnish you annually with certain tax information, and we currently do not intend to prepare or provide
such information.
Unless otherwise provided by the U.S. Treasury, each U.S. shareholder of a PFIC is required to file an annual report
containing such information as the U.S. Treasury may require. In addition, if you hold ADSs or ordinary shares in any year in which
we are a PFIC, you will be required to file Internal Revenue Service Form 8621 regarding distributions received on the ADSs or
ordinary shares and any gain realized on the disposition of the ADSs or ordinary shares. You should consult your tax advisors
regarding any reporting requirements that may apply to you.
YOU ARE STRONGLY URGED TO CONSULT YOUR TAX ADVISORS REGARDING THE IMPACT OF OUR BEING
A PFIC FOR PRIOR YEARS ON YOUR INVESTMENT IN OUR ADSs AND ORDINARY SHARES AS WELL AS THE
APPLICATION OF THE PFIC RULES AND THE POSSIBILITY OF MAKING A MARK-TO-MARKET OR DEEMED
SALE ELECTION.
Taxation of Dividends and Other Distributions on the ADSs or Ordinary Shares
Subject to the PFIC rules discussed above, the gross amount of any distribution we make to you with respect to the ADSs
or ordinary shares generally will be includible in your gross income as dividend income on the date of receipt by the depositary, in the
case of ADSs, or by you, in the case of ordinary shares, but only to the extent that the distribution is paid out of our current or
accumulated earnings and profits (as computed under U.S. federal income tax principles). The dividends will not be eligible for the
dividends-received deduction allowed to corporations in respect of dividends received from other U.S. corporations. To the extent the
amount of the distribution exceeds our current and accumulated earnings and profits, (as computed under U.S. federal income tax
principles) such excess amount will be treated first as a tax-free return of your tax basis in your ADSs or ordinary shares, and then, to
the extent such excess amount exceeds your tax basis, as a capital gain. Because we do not intend to determine our earnings and
profits on the basis of U. S. federal income tax principles, any distribution paid will generally be reported as a “dividend” for U. S.
federal income tax purposes.
With respect to certain non-corporate U.S. Holders, including individual U.S. Holders, dividends will be taxed at the lower
capital gains rate applicable to “qualified dividend income,” provided that (1) the ADSs or ordinary shares, as applicable, are readily
tradable on an established securities market in the United States, or we are eligible for the benefits of a qualifying income tax treaty
with the United States that includes an exchange of information program, (2) we are neither a PFIC nor treated as such with respect to
you for the taxable year in which the dividend was paid and the preceding taxable year, and (3) certain holding period requirements
are met. Under Internal Revenue Service authority, common or ordinary shares, or ADSs representing such shares, are considered for
the purpose of clause (1) above to be readily tradable on an established securities market in the United States if they are listed on
Nasdaq, as are our ADSs (but not our ordinary shares). There can be no assurance that our ADSs will be considered readily tradable
on an established securities market in the United States in later years. Since we do not expect that our ordinary shares will be listed on
an established securities market in the United States, it is unclear the dividends that we pay on our ordinary shares that are not backed
by ADSs currently meet the conditions required for the reduced tax rate. Furthermore, as previously disclosed, although not free from
doubt, we believed that we were a PFIC for U.S. federal income tax purposes for prior years. If we are treated as a “resident
enterprise” for PRC tax purposes under the EIT Law (see “Item 3. Key Information—D. Risk Factors—Risks Related to Our
Company and Our Industry—The PRC income tax laws may increase our tax burden or the tax burden on the holders of our shares or
ADSs, and tax benefits available to us may be reduced or repealed, causing the value of your investment in us to suffer”), we may be
eligible for the benefits of the income tax treaty between the United States and the PRC. You should consult your tax advisors
regarding the availability of the lower capital gains rate applicable to qualified dividend income for dividends paid with respect to our
ADSs or ordinary shares.
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Dividends will constitute foreign source income for foreign tax credit limitation purposes. If the dividends are taxed as
qualified dividend income (as discussed above), the amount of the dividend taken into account for purposes of calculating the foreign
tax credit limitation in general will be limited to the gross amount of the dividend, multiplied by the reduced tax rate applicable to
qualified dividend income and divided by the highest tax rate normally applicable to dividends. The limitation on foreign taxes
eligible for credit is calculated separately with respect to specific classes of income. For this purpose, dividends distributed by us with
respect to the ADSs or ordinary shares generally will constitute “passive category income” but could, in the case of certain U.S.
Holders, constitute “general category income.”
If PRC withholding taxes apply to dividends paid to you with respect to our ADSs or ordinary shares (see “Item 3. Key
Information—D. Risk Factors—Risks Related to Our Company and Our Industry— The PRC income tax laws may increase our tax
burden or the tax burden on the holders of our shares or ADSs, and tax benefits available to us may be reduced or repealed, causing
the value of your investment in us to suffer”), subject to certain conditions and limitations, such PRC withholding taxes may be
treated as foreign taxes eligible for credit against your U.S. federal income tax liability. The rules relating to the determination of the
foreign tax credit are complex, and you should consult your tax advisors regarding the availability of a foreign tax credit in your
particular circumstances, including the effects of any applicable income tax treaties.
Taxation of Disposition of the ADSs or Ordinary Shares
Subject to the PFIC rules discussed above, you will recognize taxable gain or loss on any sale, exchange or other taxable
disposition of an ADS or ordinary share equal to the difference between the amount realized (in U.S. dollars) for the ADS or ordinary
share and your tax basis (in U.S. dollars) in the ADS or ordinary share. If the consideration you receive for the ADS or ordinary share
is not paid in U.S. dollars, the amount realized will be the U.S. dollar value of the payment received. In general, the U.S. dollar value
of such a payment will be determined on the date of receipt of payment if you are a cash basis taxpayer and on the date of disposition
if you are an accrual basis taxpayer. However, if the ADSs or ordinary shares, as applicable, are treated as traded on an established
securities market and you are either a cash basis taxpayer or an accrual basis taxpayer who has made a special election, you will
determine the U.S. dollar value of the amount realized in a foreign currency by translating the amount received at the spot rate of
exchange on the settlement date of the sale. The gain or loss generally will be a capital gain or loss. If you are a non-corporate U.S.
Holder, including an individual U.S. Holder, that has held the ADS or ordinary share for more than one year, you generally will be
eligible for reduced tax rates. The deductibility of capital losses is subject to limitations.
Any gain or loss that you recognize on a disposition of ADSs or ordinary shares generally will be treated as U.S. source
income or loss for foreign tax credit limitation purposes (in the case of loss, subject to certain limitations). However, if we are treated
as a “resident enterprise” for PRC tax purposes and PRC tax were to be imposed on any gain from the disposition of the ADSs or
ordinary shares (see “Item 3. Key Information — D. Risk Factors — Risks Related to Our Company and Our Industry — The PRC
income tax laws may increase our tax burden or the tax burden on the holders of our shares or ADSs, and tax benefits available to us
may be reduced or repealed, causing the value of your investment in us to suffer”), a U.S. Holder that is eligible for the benefits of the
income tax treaty between the United States and the PRC may elect to treat the gain as PRC source income for foreign tax credit
purposes. You should consult your tax advisors regarding the proper treatment of gain or loss in your particular circumstances,
including the effect of any applicable income tax treaties.
Information Reporting
Dividend payments with respect to ADSs or ordinary shares and proceeds from the sale, exchange or redemption of ADSs
or ordinary shares generally will be subject to information reporting to the Internal Revenue Service.
U.S. Holders who are individuals generally will be required to report our name, address and such information relating to an
interest in the ADSs or ordinary shares as is necessary to identify the class or issue of which your ADSs or ordinary shares are a part.
These requirements are subject to exceptions, including an exception for ADSs or ordinary shares held in accounts maintained by
certain financial institutions and an exception applicable if the aggregate value of all “specified foreign financial assets” (as defined in
the Code) does not exceed certain thresholds.
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U.S. Holders should consult their tax advisors regarding the application of the information reporting rules.
F. Dividends and Paying Agents
Not applicable.
G.
Statement by Experts
Not applicable.
H. Documents on Display
We are subject to the periodic reporting and other informational requirements of the Exchange Act. Under the Exchange
Act, we are required to file reports and other information with the SEC. Copies of reports and other information, when so filed, may
be inspected without charge and may be obtained at prescribed rates at the public reference facilities maintained by the SEC. The
SEC also maintains a web site at www.sec.gov that contains reports, proxy and information statements, and other information
regarding Registrants that make electronic filings with the SEC using its EDGAR system. As a foreign private issuer, we are exempt
from the rules under the Exchange Act prescribing the furnishing and content of quarterly reports and proxy statements, and officers,
directors and principal shareholders are exempt from the reporting and short-swing profit recovery provisions contained in Section 16
of the Exchange Act.
Our financial statements have been prepared in accordance with U.S. GAAP.
We will furnish our shareholders with annual reports, which will include a review of operations and annual audited
consolidated financial statements prepared in conformity with U.S. GAAP.
I.
Subsidiary Information
For a listing of our subsidiaries, see “Item 4. Information on the Company—C. Organizational Structure.”
Item 11.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Interest Rate Risk
Our exposure to interest rate risk for changes in interest rates relates primarily to the interest income generated by excess
cash invested in bank deposits. We have not used any derivative financial instruments in our investment portfolio or for cash
management purposes. Interest-earning instruments carry a degree of interest rate risk. We have not been exposed nor do we
anticipate being exposed to material risks due to changes in interest rates. However, our future interest income may fall short of
expectations due to changes in interest rates.
Foreign Exchange Risk
We are exposed to foreign exchange risk arising from various currency exposures. Our payments to overseas developers, a
portion of our financial assets and the Convertible Notes are denominated in U.S. dollars and other foreign currencies, while a
significant portion of our revenues are denominated in RMB, the legal currency in China. We have not used any forward contracts or
currency borrowings to hedge our exposure to foreign currency risk. The value of the RMB against the U.S. dollar and other
currencies may fluctuate and is affected by, among other things, changes in political and economic conditions. Any significant
revaluation of RMB against the U.S. dollar may materially affect our earnings and financial position, and the value of, and any
dividends payable on, our ADS in U.S. dollars. See “Item 3. Key Information—D. Risk Factors—Risks Related to Doing Business in
China— Future movements in exchange rates between the U.S. dollar and the RMB may adversely affect the value of our ADSs.”
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A hypothetical 10% increase or decrease in the exchange rate of the U.S. dollar against the RMB would have resulted in an
increase or decrease of RMB26.0 million (US$4.0 million) in the aggregate principal amount of our U.S. dollar-denominated
convertible notes outstanding as of December 31, 2015.
Item 12.
DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES
A. Debt Securities
Not applicable.
B. Warrants and Rights
Not applicable.
C. Other Securities
Not applicable.
D. American Depositary Shares
The Bank of New York Mellon, our ADS depositary, collects its fees for delivery and surrender of ADSs directly from
investors depositing shares or surrendering ADSs for the purpose of withdrawal or from intermediaries acting for them. The
depositary collects fees for making distributions to investors by deducting those fees from the amounts distributed or by selling a
portion of distributable property to pay the fees. The depositary may collect its annual fee for depositary services by deductions from
cash distributions, or by directly billing investors, or by charging the book-entry system accounts of participants acting for them. The
depositary may generally refuse to provide fee-attracting services until its fees for those services are paid.
Persons depositing or withdrawing shares must pay:
US$5.00 (or less) per 100 ADSs (or portion of 100 ADSs)
US$0.02 (or less) per ADS
A fee equivalent to the fee that would be payable if securities
distributed to you had been shares and the shares had been
deposited for issuance of ADSs
For:
• Issuance of ADSs, including issuances resulting
from a distribution of shares or rights or other
property
• Cancellation of ADSs for the purpose of
withdrawal, including if the deposit agreement
terminates
• Any cash distribution to ADS registered holders
• Distribution of securities distributed to holders of
deposited securities that are distributed by the
depositary to ADS registered holders
US$0.02 (or less) per ADS per calendar year
• Depositary services
95
Persons depositing or withdrawing shares must pay:
Registration or transfer fees
Expenses of the depositary
For:
• Transfer and registration of shares on our share
register to or from the name of the depositary or its
agent when you deposit or withdraw shares
• Cable, telex and facsimile transmissions (when
expressly provided in the deposit agreement)
• Converting foreign currency to U.S. dollars
Taxes and other governmental charges the depositary or the
custodian have to pay on any ADS or share underlying an ADS, for
example, stock transfer taxes, stamp duty or withholding taxes
• As necessary
Any charges incurred by the depositary or its agents for servicing
the deposited securities
• As necessary
The depositary has agreed to reimburse us for expenses we incur that are related to the administration and maintenance of
our ADS facility including, but not limited to, investor relations expenses, the annual Nasdaq Stock Market continued listing fees or
any other program related expenses every year. There are limits on the amount of expenses for which the depositary will reimburse
us, but the amount of reimbursement available to us is not related to the amounts of fees the depositary collects from investors. As of
December 31, 2015, we had US$0.1 million reimbursement receivable for the year 2015, after deducting withholding tax, from the
depositary as reimbursement for legal fees and administrative expenses.
Item 13.
DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES
None.
PART II
Item 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS
Shareholder Rights Plan
On January 8, 2009, our board of directors declared a dividend of one ordinary share purchase right, or a Right, for each of
our ordinary shares outstanding at the close of business on January 22, 2009. As long as the Rights are attached to the ordinary shares,
we will issue one Right (subject to adjustment) with each new ordinary share so that all such ordinary shares will have attached
Rights. When exercisable, each Right will entitle the registered holder to purchase from us one ordinary share at a price of US$19.50
per ordinary share, subject to adjustment.
The Rights will expire on January 8, 2019, subject to our right to extend such date and are exercisable only if a person or
group obtains ownership of or announces a tender offer for 15% or more of our voting securities (including ADSs representing our
ordinary shares). Upon exercise, all Rights holders except the potential acquirer will be entitled to acquire our shares or the acquirer’s
shares at a discount. We are entitled to redeem the Rights in whole at any time on or before the acquisition by a person or group of
15% or more of our voting securities (which for these purposes include ADSs representing ordinary shares), or exchange the Rights,
in whole or in part, at an exchange ratio of one ordinary share, and of other securities, cash or other assets deemed to have the same
value as one ordinary share, per Right, subject to adjustment.
96
Use of Proceeds
Not Applicable.
Item 15.
CONTROLS AND PROCEDURES
Disclosure Controls and Procedures
Our management, with the participation of our chief executive officer and chief financial officer, has performed an
evaluation of the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act) as of
the end of the period covered by this report, as required by Rule 13a-15(b) under the Exchange Act. Based upon that evaluation, our
management has concluded that, as of December 31, 2015, our disclosure controls and procedures were effective in ensuring that the
information required to be disclosed by us in the reports that we file or submit under the Exchange Act was recorded, processed,
summarized and reported, within the time periods specified in the SEC’s rules and forms, and that the information required to be
disclosed by us in the reports that we file or submit under the Exchange Act is accumulated and communicated to our management,
including our chief executive officer and chief financial officer, to allow timely decisions regarding required disclosure.
Management’s Annual Report on Internal Control over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such
item is defined in Rules 13a-15(f) under the Exchange Act, for our company. Internal control over financial reporting is a process
designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of consolidated financial
statements in accordance with U.S. GAAP and includes those policies and procedures that (i) pertain to the maintenance of records
that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of a company’s assets, (ii) provide reasonable
assurance that transactions are recorded as necessary to permit preparation of consolidated financial statements in accordance with
generally accepted accounting principles, and that a company’s receipts and expenditures are being made only in accordance with
authorizations of a company’s management and directors, and (iii) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of a company’s assets that could have a material effect on the consolidated
financial statements.
Internal control over financial reporting cannot provide absolute assurance of achieving financial reporting objectives
because of its inherent limitations. Internal control over financial reporting is a process that involves human diligence and compliance
and is subject to lapses in judgment and breakdowns resulting from human failures. Internal control over financial reporting also can
be circumvented by collusion or improper override. Because of such limitations, there is a risk that material misstatements may not be
prevented or detected on a timely basis by internal control over financial reporting. However, these inherent limitations are known
features of the financial reporting process, and it is possible to design into the process safeguards to reduce, though not eliminate, this
risk.
As required by Section 404 of the Sarbanes-Oxley Act and related rules as promulgated by the SEC, our management
assessed the effectiveness of the internal control over financial reporting as of December 31, 2015 using criteria established in
“Internal Control—Integrated Framework (2013)” issued by the Committee of Sponsoring Organizations of the Treadway
Commission. Based on this assessment, our management concluded that our internal control over financial reporting was effective as
of December 31, 2015.
Attestation Report of the Registered Public Accounting Firm
This annual report on Form 20-F does not include an attestation report of our registered public accounting firm because our
company is neither an accelerated filer nor a large accelerated filer, as such terms are defined in Rule 12b-2 under the Exchange Act.
97
Changes in Internal Control over Financial Reporting
Our management has evaluated, with the participation of our chief executive officer and chief financial officer, whether
any changes in our internal control over financial reporting that occurred during our last fiscal year have materially affected, or are
reasonably likely to materially affect, our internal control over financial reporting. Based on the evaluation we conducted, our
management has concluded that no such changes occurred during the period covered by this annual report on Form 20-F.
Item 16A. AUDIT COMMITTEE FINANCIAL EXPERT
See “Item 6. Directors, Senior Management and Employees—C. Board Practices.”
Item 16B. CODE OF ETHICS
Our board of directors has adopted a code of ethics that applies to our directors, officers, employees and agents, including
certain provisions that specifically apply to our chief executive officer, chief financial officer, principal accounting officer, controller,
vice presidents and any other persons who perform similar functions for us. We hereby undertake to provide to any person, without
charge, a copy of our code of business conduct and ethics within ten working days after we receive such person’s written request.
Item 16C. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The following table sets forth the aggregate fees by categories specified below in connection with certain professional
services rendered by Deloitte Touche Tohmatsu Certified Public Accounts LLP, our principal external auditors for the periods
indicated below.
Audit fees(1)
Audit-related fees(2)
Tax fees(3)
2014
RMB
2015
RMB
5,275,328 4,500,000
—
152,003
—
4,924
US$
694,680
—
23,465
(1)
(2)
(3)
“Audit fees” means the aggregate fees billed in each of the fiscal years listed for professional services rendered by our principal
auditors for the audit of our annual financial statements.
“Audit-related fees” means the aggregate fees billed in each of the fiscal years listed for assurance and related services by our
principal auditors that are reasonably related to the performance of the audit or review of our financial statements and are not
reported under “Audit fees.”
“Tax fees” means the fees billed for tax compliance services, including the preparation of tax returns and tax consultations.
The policy of our audit committee is to pre-approve all audit and non-audit services provided by our independent
registered public accounting firm, including audit services, audit-related services, tax services and other services as described above,
other than those for de minimus services which are approved by our audit committee prior to the completion of the audit.
Item 16D. EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES
Not applicable.
Item 16E. PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS
None.
98
Item 16F. CHANGE IN REGISTRANT’S CERTIFYING ACCOUNTANT
Not applicable.
Item 16G. CORPORATE GOVERNANCE
We are an exempted company incorporated in the Cayman Islands and our corporate governance practices are governed by
applicable Cayman Islands law. In addition, because our ADSs are listed on the Nasdaq Global Market, we are subject to corporate
governance requirements of the Nasdaq. However, Nasdaq Marketplace Rule 5615(a)(3) permits foreign private issuers like us to
follow “home country practice” with respect to certain corporate governance matters, and we may decide to follow the “home country
practice” on a case-by-case basis. In November 2015, our board of directors approved an increase in the total number of ordinary
shares reserved for issuance under our Option Plan, for which we have followed “home country practice” in lieu of obtaining a
shareholder approval pursuant to Nasdaq Marketing Rule 5635(c). We are committed to a high standard of corporate governance. As
such, we endeavor to comply with most of the Nasdaq corporate governance practices and believe that we are currently in compliance
with the Nasdaq corporate governance practices.
Item 16H. MINE SAFETY DISCLOSURE
Not applicable.
Item 17.
FINANCIAL STATEMENTS
We have elected to provide financial statements pursuant to Item 18.
PART III
Item 18.
FINANCIAL STATEMENTS
The consolidated financial statements for The9 Limited and its subsidiaries are included at the end of this annual report.
Item 19.
EXHIBITS
Exhibit
Number
1.1
2.1
2.2
2.3
Description of Document
Amended and Restated Memorandum and Articles of Association of the Registrant as currently in effect (incorporated by
reference to Exhibit 1.1 from our Annual Report on Form 20-F filed with the Securities and Exchange Commission on
April 7, 2011)
Specimen American Depositary Receipt (incorporated by reference to Exhibit A (Form of American Depositary Receipt)
of Exhibit 1 (Form of Deposit Agreement) of our Post-Effective Amendment No. 2 to the Registration Statement on
Form F-6 (file no. 333-156635) filed with the Securities and Exchange Commission on December 3, 2010)
Specimen Certificate for Ordinary Shares of The Registrant (incorporated by reference to Exhibit 4.2 from our
Registration Statement on Form F-1 (file no. 333-120810) filed with the Securities and Exchange Commission on
November 26, 2004)
Form of Deposit Agreement dated as of December 20, 2004, as amended and restated as of January 16, 2009, as further
amended and restated as of March 20, 2009, and as further amended and restated as of December 3, 2010 among The
Registrant, The Bank of New York Mellon, as Depositary, and all Owners and Beneficial Owners from time to time of
American Depositary Shares issued thereunder (incorporated by reference to Exhibit 1 of our Post-Effective Amendment
No. 2 to the Registration Statement on Form F-6 (file no. 333-156635) filed with the Securities and Exchange
Commission on November 19, 2010)
99
Exhibit
Number
2.4
2.5
Description of Document
Rights Agreement dated as of January 8, 2009 between the Registrant and The Bank of New York Mellon, as Rights Agent
(incorporated by reference to Exhibit 4.1 from our Report of Foreign Private Issuer on Form 6-K furnished to the
Securities and Exchange Commission on January 8, 2009)
Amendment No. 1 to the Rights Agreement dated as of March 9, 2009 between the Registrant and The Bank of New York
Mellon, as Rights Agent (incorporated by reference to Exhibit 4.1 of the Report of Foreign Private Issuer on Form 6-K
furnished to the Securities and Exchange Commission on March 10, 2009)
4.1* Fifth Amended and Restated 2004 Stock Option Plan
4.2
4.3
4.4
4.5
4.6
4.7
4.8
4.9
4.10
4.11
4.12
Form of Indemnification Agreement with the Registrant’s directors and executive officers (incorporated by reference to
Exhibit 10.2 from our Registration Statement on Form F-1 Amendment No. 1 (file no. 333-120810) filed with the
Securities and Exchange Commission on November 30, 2004)
Form of Employment Agreement between the Registrant and a Senior Executive Officer of the Registrant (incorporated by
reference to Exhibit 10.3 from our Registration Statement on Form F-1 Amendment No. 1 (file no. 333-120810) filed with
the Securities and Exchange Commission on November 30, 2004)
Translation of Exclusive Technical Support Service Agreement, dated January 14, 2004, between Shanghai IT and The9
Computer (incorporated by reference to Exhibit 10.4 from our Registration Statement on Form F-1 (file no. 333-120810)
filed with the Securities and Exchange Commission on November 26, 2004)
Translation of Form of Call Option Agreement among The9 Computer, Shanghai IT and other parties therein (incorporated
by reference to Exhibit 10.6 from our Registration Statement on Form F-1 Amendment No.1 (file no. 333-120810) filed
with the Securities and Exchange Commission on November 30, 2004)
Translation of Domain Name License Agreement, dated January 1, 2004, between GameNow.net (Hong Kong) Limited
and Shanghai IT (incorporated by reference to Exhibit 10.9 from our Registration Statement on Form F-1 (file no. 333-
120810) filed with the Securities and Exchange Commission on November 26, 2004)
Translation of Form of Shareholder Voting Proxy Agreement among The9 Computer, Shanghai IT and its shareholders
(incorporated by reference to Exhibit 4.31 from our Annual Report on Form 20-F filed with the Securities and Exchange
Commission on April 7, 2011)
Translation of Equity Transfer Agreement dated October 25, 2011 between Jun Zhu and Wei Ji (incorporated by reference
to Exhibit 4.37 from our Annual Report on Form 20-F filed with the Securities and Exchange Commission on March 22,
2012)
Translation of Equity Pledge Agreement dated November 24, 2011 between Yong Wang and The9 Computer with respect
to Shanghai IT (incorporated by reference to Exhibit 4.38 from our Annual Report on Form 20-F filed with the Securities
and Exchange Commission on March 22, 2012)
Translation of Equity Pledge Agreement dated November 24, 2011 between Wei Ji and The9 Computer with respect to
Shanghai IT (incorporated by reference to Exhibit 4.39 from our Annual Report on Form 20-F filed with the Securities and
Exchange Commission on March 22, 2012)
Translation of Exclusive Call Option Agreement dated November 24, 2011 among Yong Wang, Wei Ji and The9
Computer with respect to Shanghai IT (incorporated by reference to Exhibit 4.40 from our Annual Report on Form 20-F
filed with the Securities and Exchange Commission on March 22, 2012)
Translation of Loan Agreement dated November 24, 2011 among Yong Wang, Wei Ji and The9 Computer (incorporated
by reference to Exhibit 4.41 from our Annual Report on Form 20-F filed with the Securities and Exchange Commission on
March 22, 2012)
100
Exhibit
Number
4.13
4.14
4.15
4.16
4.17
4.18
4.19
4.20
4.21
4.22
Description of Document
Translation of Shareholder Voting Proxy Agreement dated November 24, 2011 among Yong Wang, Wei Ji, The9
Computer and Shanghai IT (incorporated by reference to Exhibit 4.42 from our Annual Report on Form 20-F filed with
the Securities and Exchange Commission on March 22, 2012)
Translation of Novation Agreement dated November 25, 2011 among Jun Zhu, Wei Ji, Yong Wang, The9 Computer and
Shanghai IT (incorporated by reference to Exhibit 4.43 from our Annual Report on Form 20-F filed with the Securities
and Exchange Commission on March 22, 2012)
Translation of Exclusive Technical Service Agreement, dated December 15, 2010, between Shanghai IT and The9
Computer (incorporated by reference to Exhibit 4.44 from our Annual Report on Form 20-F filed with the Securities and
Exchange Commission on April 18, 2013)
Translation of Equity Transfer Agreement dated April 23, 2014 between Yong Wang and Zhimin Lin (incorporated by
reference to Exhibit 4.21 from our Annual Report on Form 20-F filed with the Securities and Exchange Commission on
March 27, 2015)
Translation of Equity Pledge Agreement dated April 22, 2014 between Zhimin Lin and The9 Computer with respect to
Shanghai IT (incorporated by reference to Exhibit 4.22 from our Annual Report on Form 20-F filed with the Securities
and Exchange Commission on March 27, 2015)
Translation of Exclusive Call Option Agreement dated April 22, 2014 among Zhimin Lin, Wei Ji and The9 Computer
with respect to Shanghai IT (incorporated by reference to Exhibit 4.23 from our Annual Report on Form 20-F filed with
the Securities and Exchange Commission on March 27, 2015)
Translation of Loan Agreement dated April 22, 2014 among Zhimin Lin, Wei Ji and The9 Computer (incorporated by
reference to Exhibit 4.24 from our Annual Report on Form 20-F filed with the Securities and Exchange Commission on
March 27, 2015)
Translation of Shareholder Voting Proxy Agreement dated April 22, 2014 among Zhimin Lin, Wei Ji, The9 Computer
and Shanghai IT (incorporated by reference to Exhibit 4.25 from our Annual Report on Form 20-F filed with the
Securities and Exchange Commission on March 27, 2015)
Translation of Novation Agreement dated April 22, 2014 among Yong Wang, Zhimin Lin, Wei Ji, The9 Computer and
Shanghai IT (incorporated by reference to Exhibit 4.26 from our Annual Report on Form 20-F filed with the Securities
and Exchange Commission on March 27, 2015)
Standstill Agreement dated January 8, 2009 among the Registrant, Jun Zhu and Incsight Limited (incorporated by
reference to Exhibit 4.2 from our Report of Foreign Private Issuer on Form 6-K furnished to the Securities and Exchange
Commission on January 8, 2009)
4.23*
Convertible Note and Warrant Purchase Agreement dated November 24, 2015 among the Registrant, Splendid Days
Limited and the security providers listed on Schedule 1 attached thereto
101
Exhibit
Number
8.1*
11.1
12.1*
12.2*
Description of Document
List of Significant and Other Principal Subsidiaries and Affiliated Entities of the Registrant
Amended Code of Business Conduct and Ethics of the Registrant (incorporated by reference to Exhibit 11.1 to our
annual report on Form 20-F filed with the Securities and Exchange Commission on June 30, 2005)
Certification by Principal Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
Certification by Principal Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
13.1**
Certification by Principal Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
13.2**
Certification by Principal Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
15.1*
15.2*
15.3*
15.4*
15.5*
Consent of Maples and Calder
Consent of Zhong Lun Law Firm
Consent of Deloitte Touche Tohmatsu Certified Public Accountants LLP
Consolidated financial statements of System Link Limited for the fiscal years ended December 31, 2014 and 2015
Consent of Deloitte Touche Tohmatsu Certified Public Accountants LLP, independent registered public accounting
firm of System Link Corporation Limited
101.INS*
XBRL Instance Document
101.SCH*
XBRL Taxonomy Extension Schema Document
101.CAL*
XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF*
XBRL Taxonomy Extension Definition Linkbase Document
101.LAB*
XBRL Taxonomy Extension Label Linkbase Document
101.PRE*
XBRL Taxonomy Extension Presentation Linkbase Document
*
**
Filed with this Form 20-F.
Furnished with this Form 20-F.
102
The registrant hereby certifies that it meets all of the requirements for filing on Form 20-F and that it has duly caused and
authorized the undersigned to sign this annual report on its behalf.
SIGNATURES
The9 Limited
By: /s/ Jun Zhu
Name: Jun Zhu
Title: Chairman and Chief Executive Officer
Date: April 11, 2016
103
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
THE9 LIMITED
Report of Independent Registered Public Accounting Firm
Consolidated Statements of Operations and Comprehensive Loss
for the Years ended December 31, 2013, 2014 and 2015
Consolidated Balance Sheets as of December 31, 2014 and 2015
Consolidated Statements of Changes in Equity
for the Years ended December 31, 2013, 2014 and 2015
Consolidated Statements of Cash Flows for the Years ended December 31, 2013, 2014 and 2015
Notes to Consolidated Financial Statements
Schedule 1 – Condensed Financial Information of Parent Company
F-1
Page
F-2
F-3
F-5
F-7
F-10
F-12
F-69
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders of The9 Limited:
We have audited the accompanying consolidated balance sheets of The9 Limited, its subsidiaries and its variable interest entities
(the “Group”) as of December 31, 2014 and 2015, and the related consolidated statements of operations and comprehensive loss,
changes in equity, and cash flows for each of the three years in the period ended December 31, 2015 and related financial statement
schedule included in Schedule 1. These consolidated financial statements and financial statement schedule are the responsibility of
the Group’s management. Our responsibility is to express an opinion on these consolidated financial statements and financial
statement schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States).
Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are
free of material misstatement. The Group is not required to have, nor were we engaged to perform, an audit of its internal control over
financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit
procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the
Group’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the
accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of the Group
at December 31, 2014 and 2015, and the results of their operations and their cash flows for each of the three years in the period ended
December 31, 2015, in conformity with accounting principles generally accepted in the United States of America. Also, in our
opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a
whole, presents fairly in all material respects, the information set forth therein.
Our audits also comprehended the translation of Renminbi amounts into United States dollar amounts and, in our opinion, such
translation has been made in conformity with the basis stated in Note 3. Such United States dollar amounts are presented solely for
the convenience of readers in the United States of America.
The accompanying consolidated financial statements have been prepared assuming that the Group will continue as a going
concern. As discussed in Note 2 to the consolidated financial statements, the Group’s recurring losses from operations and negative
cash flows from operations, along with other matters set forth in Note 2 in the consolidated financial statements, raise substantial
doubt about its ability to continue as a going concern. Management’s plans concerning these matters are also discussed in Note 2 to
the consolidated financial statements. The consolidated financial statements do not include any adjustments that might result from the
outcome of this uncertainty.
/s/ Deloitte Touche Tohmatsu Certified Public Accountants LLP
Shanghai, China
April 11, 2016
F-2
THE9 LIMITED
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
FOR THE YEARS ENDED DECEMBER 31, 2013, 2014 AND 2015
2013
RMB
2014
RMB
2015
RMB
2015
US$
(Note 3)
Revenues:
Online game services
Other revenues
Sales taxes
Total net revenues
Cost of revenues
Gross loss
Operating (expenses) income:
Product development
Sales and marketing
General and administrative
(Provision)/reversal of provision for allowance for long-
term receivables and prepayments
Impairment of long-lived assets
Gain on disposal of subsidiaries
Total operating expenses
Other operating income (expenses)
Loss from operations
Impairment on investments
Interest income
Interest expense
Fair value change on warrants liability
Gain on disposal of equity investee and available-for-sale
investment
Other income (expenses), net
Loss before income tax expense and share of loss in equity
method investments
Income tax expense
Share of loss in equity method investments
Net loss for the year
Net loss attributable to noncontrolling interest
Net loss attributable to redeemable noncontrolling interest
Attributable net loss to The9 Limited
Change in redemption value of redeemable noncontrolling interest
Net loss attributable to holders of ordinary shares
Other comprehensive income (loss)
Unrealized loss on available-for-sale investment
Currency translation adjustments
Total comprehensive loss
95,131,347
11,495,630
106,626,977
(1,850,908)
104,776,069
(107,803,360)
(3,027,291)
6,105,523
55,417,700 40,504,363 6,252,797
9,421,865
942,530
64,839,565 46,609,886 7,195,327
(30,652)
64,276,891 46,411,331 7,164,675
(85,782,569) (67,743,995) (10,457,871)
(21,505,678) (21,332,664) (3,293,196)
(562,674)
(198,555)
(213,243,567)
(116,672,411)
(161,958,423)
(156,253,036) (135,042,829) (20,847,020)
(51,758,100) (31,692,522) (4,892,482)
(111,157,250) (131,768,503) (20,341,552)
(29,741,076)
(5,725,046)
—
(527,340,523)
120,000
(530,247,814)
(47,970,885)
8,376,355
—
—
75,000
—
3,339,394
(8,439,580) (1,302,847)
14,371,918
—
—
165,392,382
515,514
(139,404,086) (303,604,040) (46,868,387)
(241,366)
(160,834,764) (326,500,222) (50,402,949)
—
—
119,663
775,152
(6,397,192)
(987,556)
(7,129,161) (1,100,553)
—
3,414,559
—
—
(1,563,518)
—
9,301,565
33,153,452
(963,125)
—
(1,916,755)
—
(295,896)
(560,540,779)
—
(2,375,826)
(562,916,605)
(36,655,033)
—
(526,261,572)
—
(526,261,572)
(16,600)
(688,963)
(563,622,168)
—
—
(125,229,878) (341,168,178) (52,667,291)
—
(3,712,530) (13,013,791) (2,008,983)
(128,942,408) (354,181,969) (54,676,274)
(21,443,321) (16,655,902) (2,571,228)
(20,876,617) (32,697,713) (5,047,657)
(86,622,470) (304,828,354) (47,057,389)
21,076,744 79,805,706 12,319,878
(107,699,214) (384,634,060) (59,377,267)
—
(1,203,960)
—
773,323
(130,146,368) (349,172,539) (53,902,951)
—
5,009,430
F-3
THE9 LIMITED
CONSOLIDATED STATEMENTS OF OPERATION AND COMPREHENSIVE LOSS
FOR THE YEARS ENDED DECEMBER 31, 2013, 2014 AND 2015
Comprehensive loss attributable to:
noncontrolling interest
redeemable noncontrolling interest
The9 Limited
Net loss attributable to holders of ordinary shares per share:
- Basic and diluted
Weighted average number of shares outstanding:
- Basic and diluted
2013
RMB
2014
RMB
2015
RMB
2015
US$
(35,084,526)
—
(528,537,642)
(22,995,718) (16,912,488) (2,610,838)
(20,876,617) (32,697,713) (5,047,657)
(86,274,033) (299,562,338) (46,244,456)
(22.71)
(4.65)
(16.55)
(2.56)
23,174,823
23,164,695 23,235,848 23,235,848
The accompanying notes are an integral part of these consolidated financial statements.
F-4
THE9 LIMITED
CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 31, 2014 AND 2015
ASSETS
Current assets:
Cash and cash equivalents
Accounts receivable, net of allowance for doubtful accounts of RMB480,926 and
RMB991,743 as of December 31, 2014 and 2015, respectively
Advances to suppliers
Prepayments and other current assets
Deferred costs
Amounts due from a related party
Total current assets
Investments in equity investees
Property, equipment and software, net
Goodwill
Intangible assets, net
Land use right, net
Other long-lived assets, net
TOTAL ASSETS
LIABILITIES, REDEEMABLE NONCONTROLLING INTEREST AND
SHAREHOLDERS’ EQUITY (DEFICIT)
Current liabilities:
December 31,
2014
RMB
December 31,
2015
RMB
December 31,
2015
US$
(Note 3)
181,482,300 49,010,541 7,565,924
—
9,745
733,339
898,126
11,804,750 7,153,663 1,104,335
138,647
56,573,321 9,463,149 1,460,858
—
5,250,000 10,732,643 1,656,835
255,853,455 77,258,122 11,926,599
39,223,925 267,539,694 41,301,012
36,346,230 33,846,518 5,225,002
9,746,054 10,342,694 1,596,637
97,539,341 78,876,486 12,176,431
70,273,296 68,352,386 10,551,790
290,071
517,330,710 538,094,921 83,067,542
8,348,409 1,879,021
Accounts payable (including accounts payable of the consolidated VIEs without
recourse to the Group of 15,458,464 and 7,292,389 as of December 31, 2014
and December 31, 2015 respectively)
Other taxes payable (including other taxes payable of the consolidated VIEs
without recourse to the Group of 443,467 and 266,323 as of December 31, 2014
and December 31, 2015 respectively)
Advances from customers (including advances from customers of the consolidated
VIEs without recourse to the Group of 7,192,127 and 8,913,065 as of December
31, 2014 and December 31, 2015 respectively)
Amounts due to related parties (including amounts due to related parties of the
consolidated VIEs without recourse to the Group of 7,203,895 and 11,865,648
as of December 31, 2014 and December 31, 2015 respectively)
Deferred revenue (including deferred revenue of the consolidated VIEs without
recourse to the Group of 4,990,959 and 4,732,678 as of December 31, 2014 and
December 31, 2015 respectively)
Refund of game points (including refund of game points of the consolidated VIEs
without recourse to the Group of 169,998,682 as of both December 31, 2014 and
December 31, 2015)
Warrants (including warrants of consolidated VIEs without recourse to the Group
40,213,660 41,248,455 6,367,665
932,431
551,445
85,128
16,833,165 19,605,593 3,026,582
6,304,956 77,730,267 11,999,485
20,434,962 18,552,217 2,863,969
169,998,682 169,998,682 26,243,274
of nil as of both December 31, 2014 and December 31, 2015)
— 64,414,941 9,943,953
Accrued expense and other current liabilities (including accrued expense and other
current liabilities of the consolidated VIEs without recourse to the Group of
26,346,672 and 19,082,615 as of December 31, 2014 and December 31, 2015
respectively)
Total current liabilities
Long-term accounts payable (including long-term accounts payable of the consolidated
VIEs without recourse to the Group of nil as of both December 31, 2014 and
December 31, 2015)
Long-term debt (including long-term debt of consolidated VIEs without recourse to the
41,872,851 35,864,424 5,536,514
296,590,707 427,966,024 66,066,570
18,992,201
—
—
Group of nil as of both December 31, 2014 and December 31, 2015)
— 31,726,575 4,897,739
F-5
Convertible notes (including convertible notes of consolidated VIEs without
recourse to the Group of nil as of both December 31, 2014 and December 31,
2015)
Deferred tax liabilities, non-current (including deferred tax liabilities, non-
current of the consolidated VIEs without recourse to the Group of nil as of
both December 31, 2014 and December 31, 2015)
TOTAL LIABILITIES
Commitments and contingencies (Note 33)
—
135,182,536 20,868,587
5,362,427
320,945,335
5,690,705
878,494
600,565,840 92,711,390
Redeemable noncontrolling interest (Note 31)
131,497,104
178,605,097 27,571,876
SHAREHOLDERS’ EQUITY (DEFICITS):
Ordinary shares (US$0.01 par value; 23,201,601 and 23,701,601 shares issued
and outstanding as of December 31, 2014 and December 31, 2015,
respectively)
Additional paid-in capital
Statutory reserves
Accumulated other comprehensive loss
Accumulated deficit
The9 Limited shareholders’ equity (deficit)
Noncontrolling interest
Total shareholders’ equity (deficit)
TOTAL LIABILITIES, REDEEMABLE NONCONTROLLING
INTEREST AND SHAREHOLDERS’ EQUITY (DEFICIT)
1,917,620
1,885,153
2,075,900,461
28,071,982
(8,638,604)
296,030
2,080,041,288 321,103,042
4,333,567
(520,638)
(1,999,192,344) (2,304,020,698) (355,679,505)
(197,362,396) (30,467,504)
(6,748,220)
(43,713,620)
(241,076,016) (37,215,724)
98,026,648
(33,138,377)
64,888,271
28,071,982
(3,372,588)
517,330,710
538,094,921 83,067,542
The accompanying notes are an integral part of these consolidated financial statements.
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THE9 LIMITED
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 2013, 2014 AND 2015
Cash flows from operating activities:
Net loss
Adjustments for:
Loss on disposal of property, equipment and software
Gain on disposal of subsidiaries
Employee compensation relating to the issuance of redeemable
noncontrolling interest
Share-based compensation expense
Impairment on investments
Provision/(reversal of provision) for allowance for long-term
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Allowance for doubtful accounts receivable
Impairment on upfront prepaid royalties and deferred costs
Depreciation and amortization of property, equipment and
software
Amortization of prepaid land use right
Amortization of intangible assets
Share of loss in equity method investments
Gain on disposal of investment in equity investee and
available-for-sales investment
Exchange loss (gain)
Fair value change on warrant liability
Amortization of discount on convertible note
2013
RMB
2014
RMB
2015
RMB
2015
US$
(Note 3)
(562,916,605)
(128,942,408) (354,181,969) (54,676,274)
13,137
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1,346,972
(165,392,382)
1,563,518
(3,339,394)
241,366
(515,514)
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29,237,416
47,970,885
13,034,797
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3,672,300 34,007,629 5,249,873
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29,741,076
5,725,046
1,224,425
13,096,101
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76,246
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8,439,580 1,302,847
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109,900
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711,908
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19,035,455
1,920,909
23,015,765
2,375,826
15,665,588 11,563,567 1,785,107
1,920,911
296,537
28,854,483 19,136,842 2,954,219
3,712,530 13,013,791 2,008,983
1,920,910
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3,086,602
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7,313,303 1,128,979
7,129,161 1,100,553
402,879
2,609,771
Changes in operating assets and liabilities:
Change in accounts receivable
Change in advance to suppliers
Change in prepayments and other current assets
Change in prepaid royalties
Change in deferred costs
Change in other long-lived assets
Change in accounts payable
Change in amounts due to related party
Change in other taxes payable
Change in advances from customers
Change in deferred revenue
Change in other payables and accruals
Net cash used in operating activities
(3,894,295)
(3,277,573)
23,085,521
(453,785)
(1,867,820)
13,115,217
8,665,354
4,799,753
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1,017,996
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(4,815,188)
(357,569,636)
F-10
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7,257,096
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565,870
560,406
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(1,767,972) 11,928,473 1,841,439
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1,504
58,472
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7,732,074
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1,505,203 61,454,444 9,486,931
(62,532)
(306,421)
435,897
(2,062,884)
(290,646)
321,706
(226,155)
(7,118,898)
(269,097,406) (175,586,790) (27,105,930)
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2,823,656
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(1,465,002)
Cash flows from investing activities
Decrease (Increase) in restricted cash
Proceeds from disposal of short term investment
Proceeds from disposal of subsidiaries
Proceeds from disposal of cost method investee
Proceeds from disposal of equity method investees
Proceeds from disposal of available-for-sale investment
Purchase of equity method and available-for-sale investments
Disbursement for loans receivable from a related party (including the
former equity method investee before the disposal of its equity
interest held by the Group in 2014)
Collection of loans receivable from related party (including the
former equity method investee before the disposal of its equity
interest held by the Group in 2014)
Proceeds from disposal of property, equipment and software
Proceeds from refund of investment
Refund of upfront license fees
Refund of long-term receivables
Purchase of property, equipment and software
Purchase of intangible assets
Net cash provided by (used in) investing activities
Cash flows from financing activities:
Proceeds from stock option exercises
Proceeds from exercises of stock options of a subsidiary
Issuance of redeemable noncontrolling interest
Purchase of noncontrolling interest
Repurchase of ordinary shares
Proceeds from bank borrowings
Proceeds from the issuance of convertible notes
Payment for the issuance cost related to convertible notes
Amount due to related parties
Loan from a related party
Repayment a loan from a related party
Contribution from noncontrolling interest
Payment for long-term payable
Net cash provided by (used in) financing activities
Effect of foreign exchange rate changes on cash and cash equivalents
Net change in cash and cash equivalents
Cash and cash equivalents, beginning of year
Cash and cash equivalents, end of year
Supplemental disclosure of cash flow information:
Accrued purchases of property, equipment and software
Accrued purchases of intangible assets
Receivable related to the disposition of a subsidiary
2013
RMB
2014
RMB
2015
RMB
2015
US$
37,959
877,350
—
—
700,000
—
—
—
— 163,715,759 12,178,328 1,880,010
—
—
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—
25,040,812
6,274,326
—
—
—
5,469,593
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—
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(4,500,000)
(5,250,000)
(9,870,000) (1,523,665)
4,500,000
340,962
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—
4,500,000
146,500
7,252,493
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694,680
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52,635
1,148,851
—
—
2,000,000
—
2,000,000 17,927,763 2,767,570
(3,127,931) (10,644,290) (1,643,195)
—
(2,931,808) 197,751,817 (208,995,837) (32,263,397)
—
—
4,304,447
32,603
—
84,059
—
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—
—
812,635
12,976
616,688
—
— 118,262,180
(101,392)
—
—
—
(29,030,699)
—
— 31,624,560 4,881,991
—
— 260,068,680 40,147,686
—
— (20,779,520) (3,207,805)
—
—
—
400,976
— 30,000,000 4,631,202
—
— (30,000,000) (4,631,202)
—
694,680
—
—
(13,995,293)
(19,469,853) (19,501,485) (3,010,511)
(38,688,942) 100,221,650 257,936,935 39,818,601
(899,389)
(4,380,962)
1,898,778
(397,291,608)
24,495,099 (132,471,759) (20,450,115)
554,278,809 156,987,201 181,482,300 28,016,039
156,987,201 181,482,300 49,010,541 7,565,924
(5,826,067)
2,597,440
4,500,000
2,085,286
56,109,371
—
1,747,081
284,285
36,775,866 20,010,351 3,089,066
—
12,750,000
1,841,541
—
Details of the non-cash transactions regarding disposal of Jiucheng Advertisement and Red 5 are set out in Note 7 and Note 30.
The accompanying notes are an integral part of these consolidated financial statements.
F-11
THE9 LIMITED
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 2013, 2014 AND 2015
1. ORGANIZATION AND NATURE OF OPERATIONS
The accompanying consolidated financial statements include the financial statements of The9 Limited (the “Company”), which was
incorporated on December 22, 1999 in the Cayman Islands, its subsidiaries and variable interest entities (“VIE subsidiaries” or
“VIEs”).
The Company, its subsidiaries and VIE subsidiaries are collectively referred to as the “Group”. The Group is principally engaged in
the development and operation of online games and internet related businesses, including massively multiplayer online games
(“MMOGs”), mobile games and TV games. The Group commercial launched Firefall, a proprietary game developed by Red 5 in
North America and Europe in 2014. It conducted a limited commercial release in China in November 2015 and expect to have a
large-scale commercial launch in China in the second half of 2016. The Group also expect to launch a proprietary mobile game, Song
of Knights in 2016.
The Company’s principal subsidiaries and VIE subsidiaries are as follows as of December 31, 2015:
Name of entity
Subsidiaries:
GameNow.net (Hong Kong) Limited (“GameNow
Hong Kong”)
The9 Computer Technology Consulting (Shanghai)
Co., Ltd. (“The9 Computer”)
China The9 Interactive Limited (“C9I”)
China The9 Interactive (Shanghai) Limited (“C9I
Shanghai”)
9Dream Limited (“9Dream”)
China The9 Interactive (Beijing) Limited (“C9I
Beijing”)
Jiu Jing Era Information Technology (Beijing) Limited
(“Jiu Jing”)
Jiu Tuo (Shanghai) Information Technology Limited
(“Jiu Tuo”)
China Crown Technology Limited (“China Crown
Technology”)
Asian Way Development Limited (“Asian Way”)
New Star International Development Limited (“New
Star”)
The9 Development Center Limited (“TDC”)
F-12
Date of
incorporation
Place of
incorporation
Legal Ownership
January-00
Hong Kong
June-00
October-03
PRC
Hong Kong
February-05
July-05
PRC
Hong Kong
March-07
April-07
July-07
PRC
PRC
PRC
November-07
November-07
Hong Kong
Hong Kong
January-08
June-08
Hong Kong
Hong Kong
100%
100%
100%
100%
100%
100%
100%
100%
100%
100%
100%
100%
TDC (Asia) Limited (“TDC Asia”)
Red 5 Studios, Inc. (“Red 5”)
Red 5 Singapore Pte. Ltd. (“Red 5
Singapore”)
The9 Interactive, Inc. (“The9 Interactive”)
The9 Korea Co., Ltd. (“The9 Korea”)
Red 5 Korea LLC. (“Red 5 Korea”)
City Channel Ltd. (“City Channel”)
Variable interest entity:
Shanghai The9 Information Technology Co.,
Ltd. (“Shanghai IT”)
Shanghai Mengxiang Hulian Digital
Technology Co., Ltd. (“Mengxiang
Hulian”)
Shanghai Fire Wing Information Technology
Co., Ltd. (“Shanghai Fire Wing”)
Subsidiaries of Shanghai IT:
Name of entity
Shanghai Jiushi Interactive Network
Technology Co., Ltd. (“Jiushi”)
Shanghai The9 Education Technology Co.,
Ltd. (“The9 Education”)
Beijing Chuan Yun Interactive Network
Technology Co., Ltd. (“Chuan Yun”)
Shanghai Jiu Chang Investment Co., Ltd.
(“Jiu Chang”)
Hangzhou Firerain network Technology Co.,
Ltd.(“HZ Firerain”)
Shanghai Shencai Chengjiu information
technology co., Ltd. (“SH Shencai”)
Wuxi Chuang You Technology Co., Ltd.
(“Chuang You”)
2. PRINCIPAL ACCOUNTING POLICIES
<1> Basis of presentation
April-09
June-05
British Virgin Islands
USA
April-10
June-10
February-11
November-10
June-06
Singapore
USA
Korea
Korea
Hong Kong
100%
73%
73%
100%
100%
100%
100%
September-00
December-11
January-12
PRC
PRC
PRC
N/A (Note 4)
20% (Note 4)
N/A
Date of
incorporation
Place of
incorporation
Legal Ownership Held
by Shanghai IT
PRC
PRC
PRC
PRC
PRC
PRC
PRC
July-11
May-12
February-14
December-14
October- 08
May-15
July-15
F-13
80%
70%
100%
100%
100%
100%
100%
The accompanying consolidated financial statements have been prepared in accordance with generally accepted accounting principles
in the United States of America (“US GAAP”). Significant accounting policies followed by the Group in the preparation of the
accompanying consolidated financial statements are summarized below.
The accompanying consolidated financial statements have been prepared on a going concern basis. The Group has accumulated
deficit of approximately RMB2,304 million (US$355.7 million) as of December 31, 2015, a net loss of approximately RMB354.2
million (US$54.7 million) for the year ended December 31, 2015. The Group expects to continue to incur product development, and
sales and marketing expenses for licensed and proprietary new games in order to achieve overall revenue growth. These factors raise
substantial doubt about the Group’s ability to continue as a going concern. The accompanying consolidated financial statements do
not include any adjustments relating to the recoverability and classification of recorded asset amounts or amounts of liabilities that
might result from the outcome of this uncertainty.
To meet its capital needs, the Group is considering multiple alternatives, including, but not limited to, additional equity financings,
debt financings and other funding transactions as outlined below. There can be no assurance that the Group will be able to complete
any such transaction on acceptable terms or otherwise. If the Group is unable to obtain the necessary capital, it will need to pursue a
plan to license or sell its assets, seek to be acquired by another entity and/or cease operations.
Sales of Equity Interest of Red 5
In March 2016, the Group entered into a non-binding memorandum of understanding (“MOU”) with L&A International Holding
Limited (“L&A”), a Cayman Island Company with shares publicly listed in Hong Kong, and a certain other shareholder of Red 5
Studios, Inc. (“Red 5”). Under the terms of this MOU, the Group will exchange approximately 30.6% of its equity interest in Red 5
for such number of newly issued shares of L&A of equivalent value based on a valuation agreed by all parties. The other participating
shareholders of Red 5 will exchange an aggregate of approximately 14.4% equity interest in Red 5 based on the same terms. The total
valuation for the 45% of equity interest in Red 5 subject to this exchange is expected to be approximately US$76.5 million, subject to
adjustments by no more than 15% based on the results of due diligences conducted by both parties. The completion of the transaction
is subject to the parties’ execution of definitive agreements and customary closing conditions to be stipulated therein. Should the
transaction is to be completed in accordance with valuation of the MOU, the Group is expected to receive ordinary shares of L&A
with a valuation ranging between US$44 million to US$60 million. The Group expect these shares to be publicly traded and without
restriction for sale in the public market in Hong Kong. As such, the Group believes the completion of this transaction can provide a
source of funding for its operations.
F-14
Addition external debt financing
In March 2016, Bank of Shanghai (BOS) issued a commitment letter whereby BOS agrees to grant the Group a credit facility of
RMB50 million (US$7.7 million). The Group can apply to withdraw the funding from BOS should they require liquidity for its
operations. As of the report date, the Group had withdrawn RMB4.9 million (US$0.8 million) under this credit facility.
Launch of new games
The Group plans to have a large-scaled commercial launch of Firefall in China in the second half of 2016. In addition, The Group
plans to launch the proprietary mobile game Song of Knights in 2016. We had already licensed Song of Knights to different game
operators for distribution in Korea, Vietnam, Taiwan, Malaysia, Hong Kong, Singapore and Macau.
Cost Control
The Group does not have significant short term loans or liabilities to third parties. Currently the biggest use of cash for the Group is
payroll related costs. When Management deems it is necessary, the Group has the ability to control the level of discretionary spending
on payroll by reducing the headcount of the Group within a short period of time.
<2> Consolidation
The consolidated financial statements include the financial statements of the Company, its subsidiary and VIEs in which it has a
controlling financial interest. The results of the subsidiary are consolidated from the date on which the Company obtained control and
continue to be consolidated until the date that such control ceases. A controlling financial interest is typically determined when a
company holds a majority of the voting equity interest in an entity. However, if the company demonstrates its ability to control the
VIEs through its rights to all the residual benefits of the VIEs and its obligation to fund losses of the VIEs then the entity is
consolidated. All intercompany balances and transactions between the Company, its subsidiary and VIEs have been eliminated in
consolidation.
F-15
PRC laws and regulations currently prohibit or restrict foreign ownership of internet-related business. In September 2009, the General
Administration of Press and Publication (“GAPP”) further promulgated the Circular Regarding the Implementation of the Department
Reorganization Regulation by State Council and Relevant Interpretation by State Commission Office for Public Sector Reform and
the Further Strengthening of the Administration of Pre-approval on Online Games and Approval on Import Online Games, or the
GAPP Circular. It is not clear that the regulatory authority of the GAPP applies to the regulation of ownership structures of online
game companies based in the PRC. While the GAPP Circular is applicable to the Group and its business in terms of publication and
pre-approval of online games, to date, GAPP has not issued any interpretation of Section 4 of the GAPP Circular to specifically
invalidate VIE agreements and, to the Group’s knowledge, has not taken any enforcement action under Section 4 of the GAPP
Circular against any of the companies that rely on contractual arrangements with VIEs to operate online games in the PRC. Therefore,
the Group believes that its ability to direct the activities of VIEs that most significantly impact their economic performance is not
affected by the GAPP Circular.
<3> Use of estimates
The preparation of the consolidated financial statements in conformity with US GAAP requires management to make estimates and
assumptions that affected the reported amount of the assets and liabilities, the disclosure of contingent assets and liabilities at the date
of the financial statements, and the reported revenues and expenses during the reported periods. Significant accounting estimates
reflected in the Group’s consolidated financial statements include the valuation of non-marketable equity investments and
determination of other-than temporary impairment, allowance for doubtful accounts and prepayment, revenue recognition, assessment
of recoverability of long-lived assets and goodwill impairment, assessment of impairment of other long-lived assets, fair value of
redeemable noncontrolling interest, the fair value of the warrants, share-based compensation expense, consolidation of VIEs,
valuation allowances for deferred tax assets and contingencies. Such accounting policies are impacted significantly by judgments,
assumptions and estimates used in the preparation of our consolidated financial statements, and actual results could differ materially
from these estimates.
<4> Foreign currency translation
The Group’s reporting currency is Renminbi (“RMB”). The Group’s functional currency with the exception of its subsidiaries, Red 5,
The9 Interactive, Red 5 Singapore, Red5 Korea and The9 Korea, is the RMB. The functional currency of Red 5, The9 Interactive,
Red 5 Singapore, Red5 Korea and The9 Korea is United States Dollar (“US$”, or “US dollars”), United States Dollar, Singapore
Dollar, Korean Won and Korean Won, respectively. Assets and liabilities of Red 5, The9 Interactive, Red 5 Singapore, Red5 Korea
and The9 Korea are translated at the current exchange rates quoted by the People’s Bank of China (the “PBOC”) in effect at the
balance sheet dates. Equity accounts are translated at historical exchange rates and revenues and expenses are translated at the
average exchange rates in effect during the reporting period to RMB. Gains and losses resulting from foreign currency translation to
reporting currency are recorded in accumulated other comprehensive loss in the consolidated statements of changes in equity for the
years presented.
F-16
Transactions denominated in currencies other than functional currencies, are translated into functional currencies at the exchange
rates prevailing at the dates of the transactions. Gains and losses resulting from foreign currency transactions are included in the
consolidated statements of operations and comprehensive loss. Monetary assets and liabilities denominated in foreign currencies are
translated into functional currencies using the applicable exchange rates at the balance sheet dates. All such exchange gains and losses
are included in other income (expense) in the consolidated statements of operations and comprehensive loss.
<5> Cash and cash equivalents
Cash and cash equivalents represent cash on hand and highly-liquid investments with an original maturity date of three months or
less. At December 31, 2014 and 2015, cash equivalents were comprised primarily of bank deposits. Included in cash and cash
equivalents as of December 31, 2014 and 2015 are amounts denominated in US Dollars totaling US$4.9 million and US$0.1 million,
respectively.
The RMB is not a freely convertible currency. The PRC State Administration for Foreign Exchange, under the authority of the
People’s Bank of China, controls the conversion of RMB into foreign currencies. The value of the RMB is subject to changes in
central government policies and to international economic and political developments affecting supply and demand in China’s foreign
exchange trading system market. The Company’s aggregate amount of cash and cash equivalents denominated in RMB amounted to
RMB150.5 million and RMB48.1 million (US$7.4 million) as of December 31, 2014 and 2015, respectively.
<6> Allowance for doubtful accounts
Accounts receivable mainly consist of receivables from prepaid card distributors and third party game platforms, and are recorded net
of allowance for doubtful accounts. The Group determines the allowances for doubtful accounts when facts and circumstances
indicate that the receivable is unlikely to be collected. Allowances for doubtful accounts are charged to general and administrative
expenses. If the financial condition of the Group’s customers were to deteriorate, resulting in an impairment of their ability to make
payments, additional allowances may be required. The Company provided allowance for doubtful accounts of RMB1.2 million,
RMB0.08 million and RMB0.7 million (US$0.1 million) in 2013, 2014 and 2015, respectively.
<7> Prepaid royalties and deferred costs
Royalties paid to the licensors of games are initially recognized as prepaid royalties when paid and subsequently recognized as
deferred costs upon the customers’ online registration and activation of their cards or online points. Royalties payable to the licensors
or receivable from collection agents upon customers’ charging their accounts are initially recorded as deferred costs upon the
customers’ online registration and activation of their cards or online points. Deferred costs are then ultimately recognized as cost of
services in the consolidated statements of operations and comprehensive loss based upon the actual consumption of game premium
features or usage of the game playing time by the customers or when the likelihood that the Group would provide further services to
those customers becomes remote.
F-17
<8> Investments in equity method investee and loan to equity method investee
Equity investments are comprised of investments in privately held companies. The Group uses the equity method to account for an
equity investment over which it has the ability to exert significant influence but does not otherwise control. The Group records equity
method investments at the cost of acquisition, plus the Group’s share in undistributed earnings and losses since acquisition. For equity
investments over which the Group does not have significant influence or control, the cost method of accounting is used.
The Group has historically provided loans to certain equity investees in order to provide to them financial support.
If the Group’s share of losses of the undistributed losses exceeds the carrying amount of an investment accounted for by the equity
method, the Group continues to report losses up to the investment carrying amount, including any loans balance to the equity
investees.
The Group assesses its equity investments and loans to equity investees for impairment on a periodic basis by considering factors
including, but not limited to, current economic and market conditions, the operating performance of the investees including current
earnings trends, the technological feasibility of the investee’s products and technologies, the general market conditions in the
investee’s industry or geographic area, factors related to the investee’s ability to remain in business, such as the investee’s liquidity,
debt ratios, and cash burn rate and other company-specific information including recent financing rounds. If it has been determined
that the equity investment is less than its related fair value and that this decline is other-than-temporary, the carrying value of the
investment and loan to equity investee is adjusted downward to reflect these declines in value.
<9> Available-for-sale investments
Investments in debt and equity securities are, on initial recognition, classified into the three categories: held-to-maturity securities,
trading securities and available-for-sale securities. Debt securities that the Company has the positive intent and ability to hold to
maturity are classified as held-to-maturity securities and reported at amortized cost. Debt and equity securities that are bought and
held principally for the purpose of selling them in the near term are classified as trading securities and reported at fair value, with
unrealized gains and losses included in earnings. Debt and equity securities not classified as either held-to-maturity securities or
trading securities are classified as available-for-sale securities and reported at fair value, with unrealized gains and losses recognized
in accumulated other comprehensive income. As of December 31, 2014 and 2015, the Group did not hold trading securities or held-
to-maturity securities.
F-18
When there is objective evidence that an available-for-sale investment is impaired, the cumulative losses from declines in fair value
that had been recognized directly in other comprehensive income are removed from equity and recognized in earnings. When the
available-for-sale investment is sold, the cumulative fair value adjustments previously recognized in accumulated other
comprehensive income are recognized in the current period operating results. When the Group determines that the impairment of an
available-for-sale equity security is other-than-temporary, the Group recognizes an impairment loss in earnings equal to the difference
between the investment’s cost and its fair value at the balance sheet date of the reporting period for which the assessment is made.
When other-than-temporary impairment has occurred for an available-for-sale debt security and the Group intends to sell the security
or more likely than not will be required to sell the security before recovery of its amortized cost basis less any current-period credit
loss, an impairment loss is recognized in earnings equal to the difference between the investment’s amortized cost basis and its fair
value at the balance sheet date. The new cost basis will not be changed for subsequent recoveries in fair value. To determine whether
a loss is other-than-temporary, the Group reviews the cause and duration of the impairment, the extent to which fair value is less than
cost, the financial condition and near-term prospects of the issuer, and the Group’s intent and ability to hold the security for a period
of time sufficient to allow for any anticipated recovery of its amortized cost.
<10> Property, equipment and software
Property, equipment and software are stated at cost less accumulated depreciation and amortization. Depreciation and amortization
are computed using the straight-line method over the following estimated useful lives:
the shorter of respective term of the leases or the estimated useful lives of the leasehold improvements
Leasehold improvements
Computer and equipment
Software
Office furniture and
fixtures
Motor vehicles
Office buildings
3 to 4 years
5 years
3 years
5 years
10 to 20 years
<11> Goodwill
F-19
Goodwill represents the excess of the purchase price over the fair value of the identifiable assets and liabilities acquired as a result of
the Group’s business acquisition. Goodwill is tested for impairment annually or more frequently if events or changes in circumstances
indicate that it might be impaired. In September 2011, the Financial Accounting Standards Board (“FASB”) issued an authoritative
pronouncement related to testing goodwill for impairment. The guidance permits us to first assess qualitative factors to determine
whether it is “more likely than not” that the fair value of a reporting unit is less than its carrying amount as a basis for determining
whether it is necessary to perform the two-step goodwill impairment test. The Company adopted this pronouncement since 2012. If it
is more likely than not that the fair value of a reporting unit is less than its carrying amount, the Group completes a two-step goodwill
impairment test in December of each year. The first step compares the fair value of each reporting unit to its carrying amount,
including goodwill. If the fair value of a reporting unit exceeds its carrying amount, goodwill is not considered to be impaired and the
second step will not be required. If the carrying amount of a reporting unit exceeds its fair value, the second step compares the
implied fair value of goodwill to the carrying value of a reporting unit’s goodwill. The implied fair value of goodwill is determined in
a manner similar to accounting for a business combination with the allocation of the assessed fair value determined in the first step to
the assets and liabilities of the reporting unit. The excess of the fair value of the reporting unit over the amounts assigned to the assets
and liabilities is the implied fair value of goodwill. This allocation process is only performed for purposes of evaluating goodwill
impairment and does not result in an entry to adjust the value of any assets or liabilities. An impairment loss is recognized for any
excess in the carrying value of goodwill over the implied fair value of goodwill.
<12> Intangible assets
Intangible assets consist primarily of acquired game licenses and acquired game development costs from business combinations.
Acquired game licenses are amortized on a straight-line basis over the shorter of the useful economic life of the relevant online game
or license period, which range from two to seven years. Amortization of acquired game licenses commences upon the monetization of
the related online game.
The Group recognizes intangible assets acquired through business acquisitions as assets separate from goodwill. Acquired in-process
research and development costs are initially considered an indefinite-lived asset. Subsequently, they are recorded as acquired game
development cost upon completion of the research and development efforts and are amortized on a straight-line basis over the useful
economic life of the relevant online game. Amortization of acquired game development cost commences upon the monetization of the
related online game
<13> Land use right
Land use right represents operating lease prepayments to the PRC’s land bureau for usage of the parcel of land where the Group’s
office building is located. Amortization is calculated using the straight-line method over the estimated land use right period of 44
years.
<14> Impairment of long-lived assets and allowance on long-term receivables
F-20
The Group evaluates its long-lived assets, including finite-lived intangible assets, for impairment whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be recoverable or that the useful life is shorter than the Group had
originally estimated. The Group assesses the recoverability of the long-lived assets by comparing the carrying amount to the
estimated future undiscounted cash flow expected to result from the use of the assets and their eventual disposition. If the sum of the
expected undiscounted cash flows is less than the carrying amount of the assets, the Group would recognize an impairment loss based
on the fair value of the assets.
Indefinite-lived intangible assets are tested for impairment annually or more frequently if events or changes in circumstances indicate
that the asset might be impaired. The impairment test consists of a comparison of the fair value of the intangible asset to its carrying
amount. If the carrying amount exceeds the fair value, an impairment loss is recognized in an amount equal to that excess.
The Group determines an allowance on doubtful long-term receivables when facts and circumstances indicate that the long-term
receivable is unlikely to be collected. When the collectability of the long-term receivable became likely subsequently, the Group
reverses the allowance
<15>Revenue recognition
Online game services
The Group earns revenue from provision of online game operation services to players on the Group’s game servers and third party
platform and overseas licensing of the online game to other operators. The Group recognizes revenues when persuasive evidence of
an arrangement exists, services are delivered or performed, our price is fixed or determinable and collectability is reasonably assured.
Online game services to players on the Group’s game server
The Group sells its prepaid online points for its online game products directly to players via certain online payment platforms. The
Group adopts virtual item / service consumption model for the online game services.
Players can access certain games free of charge, but may purchase game points to acquire in-game premium features. The distribution
of points to players is typically made by sales of prepaid game cards and prepaid online points. Fees for prepaid game cards and
prepaid online points are deferred when received. Revenue is recognized over the estimated life of the premium features or as the
premium features are consumed.
F-21
For in-game premium features that are immediately consumed, revenue is recognized upon consumption. For premium features with
a stated expiration time, which range from one to 180 days, revenue is recognized ratably over the period starting from when the
feature is first used to the expiration time. For perpetual features with no predetermined expiration, revenue is recognized ratably over
the estimated average lives of the perpetual features, which are typically less than one year. When estimating the average lives of the
in-game perpetual features, the Group considers the average period that players typically play the game, other player behavior
patterns, and factors including the acceptance and popularity of expansion packs, promotional events launched, and market
conditions. Future usage patterns of players may differ from the historical usage patterns on which the virtual item / service
consumption revenue recognition model is based. The Group continually monitors the operational statistics and usage patterns.
Online game operation services over third party platform
Certain social games, TV games, certain web games and certain MMOGS, have adopted the virtual item / service consumption
model, and are launched on the third party game platforms and telecom carriers. Revenue from social and web games operated
through third party game platforms are recognized upon consumption of the in-game premium features with the amount net of
remittance to the third party game platforms as the Group does not set the pricing of the in-game currency of the third party game
platforms.
Revenue from TV games operated through telecom carriers and certain MMOGS operated on the third party game platforms are
recognized upon consumption of the in-game premium features based on the gross amount paid, as the Group is the primary obligor
of the games operation. The remittance to the telecom carrier and third party game platforms is recognized as costs of revenue when
incurred.
Licensing revenue
The Group licenses certain proprietary online games to other game operators and receives license fees and royalty income in
connection with their operation of the games. License fee revenue is recognized over the license period upon the commercialization
of the game in the licensees’ market. Royalty income is recognized when earned, provided that collectability is reasonably assured.
Other revenues
Other revenues mainly include those generated from training. Training revenue include revenues generated from providing technical
training to college students on mobile application programming. These revenues are recognized when delivery of the service has
occurred or when services have been rendered and the collection of the related fees is reasonably assured.
<16>Advances from customers and deferred revenue
Online points that have been sold but not activated are recognized as advances from customers. Online points that have been activated
but for which online game services will be rendered in the future are recognized as deferred revenue. Deferred revenue is recognized
as income based upon the actual consumption of in-game premium features by players or when the likelihood that the Group would
provide further online game service to those customers is remote.
F-22
The Group licenses proprietary games to operators in other countries and receives license fees and royalty income. License fee
received in advance of the monetization of the game is recorded in advances from operators.
<17>Convertible note and warrants
Convertible Notes and Beneficial Conversion Feature (“BCF”)
The Group issued convertible notes and warrants in December 2015. The Group has evaluated whether the conversion feature of the
notes is considered an embedded derivative instrument subject to bifurcation in accordance with ASC 815, Accounting for Derivative
Instruments and Hedging Activities. Based on the Group’s evaluation, the conversion feature is not considered an embedded
derivative instrument subject to bifurcation as conversion option does not provide the holder of the notes with means to net settle the
contracts. Convertible notes, for which the embedded conversion feature does not qualify for derivative treatment, are evaluated to
determine if the effective rate of conversion per the terms of the convertible note agreement is below market value. In these instances,
the value of the BCF is determined as the intrinsic value of the conversion feature is recorded as deduction to the carrying amount of
the notes and credited to additional paid-in-capital. For convertible notes issued with detachable warrants, a portion of the note’s
proceed is allocated to the warrant based on the fair value of the warrants at the date of issuance. The allocated fair value for the
warrants and the value of the BCF are both recorded in the financial statements as a debt discount from the face amount of the notes,
which is then accreted to interest expense over the life of the related debt using the effective interest method.
The Group has early adopted ASU 2015-3, simplifying the presentation of debt issuance costs to present the occurred debt issuance
costs as a direct deduction from the convertible note rather than as an assets. Amortization of the costs is reported as interest expense.
Warrants
The Group accounts for the detachable warrants issued in connection with convertible notes under the authoritative guidance on
accounting for derivative financial instruments indexed to, and potentially settled in, a company's own stock. The Group classifies
warrants in its consolidated balance sheet as a liability which is revalued at each balance sheet date subsequent to the initial issuance.
The Group uses the Black-Scholes pricing model to value the warrants. Determining the appropriate fair-value model and calculating
the fair value of warrants requires considerable judgment. A small change in the estimates used may cause a relatively large change in
the estimated valuation. The estimated volatility of the Group’s common stock at the date of issuance, and at each subsequent
reporting period, is based on historic fluctuations in the Company’s stock price. The risk-free interest rate is based on United States
Treasury zero-coupon issues with a maturity similar to the expected remaining life of the warrants at the valuation date. The expected
life of the warrants is based on the historical pattern of exercises of warrants.
F-23
<18>Cost of revenue
Cost of revenue consists primarily of online game royalties, payroll, sharing to third party game platform, telecom carries and other
suppliers, depreciation, maintenance and rental of Internet data center sites, depreciation and amortization of computer equipment and
software, production costs for prepaid game cards, intangible assets amortization and other overhead expenses directly attributable to
the services provided.
<19>Product development costs
For software development costs, including online games, to be sold or marketed to customers, the Group expenses software
development costs incurred prior to reaching technological feasibility. Once a software product has reached technological feasibility,
all subsequent software costs for that product are capitalized until that product is released for marketing. After an online game is
released, the capitalized product development costs are amortized over the estimated product life. To date, the Group has essentially
completed its software development concurrently with the establishment of technological feasibility, and, accordingly, no costs have
been capitalized.
For website and internally used software development costs, the Group expenses all costs that are incurred in connection with the
planning and implementation phases of development and costs that are associated with repair or maintenance of the existing websites
and software. Costs incurred in the application and infrastructure development phase are capitalized and amortized over the estimated
product life. Since the inception of the Group, the amount of internally generated costs qualifying for capitalization has been
immaterial and, as a result, all website and internally used software development costs have been expensed as incurred.
Product development costs consist primarily of outsourced research and development expenses, payroll, depreciation charge and
other overhead expenses for the development of the Group’s proprietary games. Other overhead product development costs include
costs incurred by the Group to develop, maintain, monitor, and manage its websites.
<20>Sales and marketing expenses
Sales and marketing expenses consist primarily of advertising and promotional expenses, payroll and other overhead expenses
incurred by the Group’s sales and marketing personnel. Advertising expenses in the amount of RMB52.8 million, RMB22.5 million
and RMB3.2 million (US$0.5 million) for the years ended December 31, 2013, 2014 and 2015, respectively, were expensed as
incurred.
<21>Government grants
Unrestricted government subsidies from local government agencies allowing the Group full discretion to utilize the funds were RMB
1.0 million, RMB1.2 million and RMB0.3 million (US$0.04 million) for the years ended December 31, 2013, 2014 and 2015,
respectively, which were recorded in other income (expense) in the consolidated statements of operations and comprehensive loss.
F-24
<22>Share-based compensation
The Group has granted share-based compensation awards to certain employees under several equity plans. The Group measures the
cost of employee services received in exchange for an equity award, based on the fair value of the award at the date of grant. Share-
based compensation expense is recognized net of estimated forfeitures, determined based on historical experience. The Group
recognizes share-based compensation expense over the requisite service period. For performance and market-based awards which
also require a service period, the Group uses graded vesting over the longer of the derived service period or when the performance
condition is considered probable. The Company determines the grant date fair value of stock options using a Black-Scholes-Merton
option pricing model (the “Black-Scholes Model”) with assumptions made regarding expected term, volatility, risk-free interest rate,
and dividend yield. The fair value of the stock options containing a market condition are estimated using a Monte Carlo simulation
model. For options awarded by private subsidiaries of the Group, the fair value of shares is estimated based on the equity value of the
subsidiary. The Group evaluates the fair value of the subsidiary by making judgments and assumptions about the projected financial
and operating results of the subsidiary. Once the equity value of the subsidiary is determined, it is allocated (as applicable) into the
various classes of shares and options using the option-pricing method, which is one of the generally accepted valuation
methodologies.
The expected term represents the period of time that stock-based awards granted are expected to be outstanding. The expected term of
stock-based awards granted is determined based on historical data on employee exercise and post-vesting employment termination
behavior. Expected volatilities are based on historical volatilities of the Company’s ordinary shares. Risk-free interest rate is based on
United States (“US”) government bonds issued with maturity terms similar to the expected term of the stock-based awards.
The Group recognizes compensation expense, net of estimated forfeitures, on all share-based awards on a straight-line basis over the
requisite service period, which is generally a one-to-four year vesting period or in the case of market-based awards, over the greater
of the vesting period or derived service period. Forfeiture rate is estimated based on historical forfeiture patterns and adjusted to
reflect future changes in circumstances and facts, if any. If actual forfeitures differ from those estimates, the estimates may need to be
revised in subsequent periods. The Group uses historical data to estimate pre-vesting option forfeitures and record stock-based
compensation expense only for those awards that are expected to vest.
F-25
For stock option modifications, the Group compares the fair value of the original award immediately before and after the
modification. For modifications, or probable-to-probable vesting conditions, the incremental fair value of fully vested awards is
recognized as expense on the date of the modification, with the incremental fair value of unvested awards recognized ratably over the
new service period.
<23>Leases
Leases for which substantially all of the risks and rewards of ownership of assets remain with the leasing company are accounted for
as operating leases. Payments made under operating leases net of any incentives received by the Group from the leasing company are
charged to the consolidated statements of operations and comprehensive loss on a straight-line basis over the lease periods.
<24>Income taxes
Current income taxes are provided for in accordance with the laws and regulations applicable to the Group as enacted by the relevant
tax authorities. Income taxes are accounted for under the asset and liability method. Deferred taxes are determined based upon
differences between the financial reporting and tax bases of assets and liabilities at currently enacted statutory tax rates for the years
in which the differences are expected to reverse. The effect on deferred taxes of a change in tax rates is recognized as income in the
period of change. A valuation allowance is provided on deferred tax assets to the extent that it is more likely than not that such
deferred tax assets will not be realized. The total income tax provision includes current tax expenses under applicable tax regulations
and the change in the balance of deferred tax assets and liabilities.
The Group recognizes the impact of an uncertain income tax position at the largest amount that is more-likely-than not to be sustained
upon audit by the relevant tax authority. Income tax related interest is classified as interest expenses and penalties as income tax
expense.
<25> Redeemable non-controlling interests
Redeemable non-controlling interests are equity interests of our consolidated subsidiary not attribute to the Group that have
redemption features that are not solely within the Group’s control. These interests are classified as temporary equity because their
redemption is considered probable. These interests are measured at the greater of estimated redemption value at the end of each
reporting period or the initial carrying amount of the redeemable non-controlling interests adjusted for cumulative earnings (loss)
allocations.
<26> Noncontrolling interest
A noncontrolling interest in a subsidiary or VIE of the Group represents the portion of the equity (net assets) in the subsidiary or VIE
not directly or indirectly attributable to the Group. Noncontrolling interests is presented as a separate component of equity in the
consolidated balance sheet and modifies the presentation of net income by requiring earnings and other comprehensive income loss to
be attributed to controlling and noncontrolling interest.
F-26
<27> Loss per share
Basic loss per share is computed by dividing net loss attributable to the holders of ordinary shares by the weighted average number of
ordinary shares outstanding during the year. Diluted loss per share is calculated by dividing net income attributable to the holders of
ordinary shares as adjusted for the effect of dilutive ordinary share equivalents, if any, by the weighted average number of ordinary
shares and dilutive ordinary share equivalents outstanding during the period. Ordinary share equivalents of stock options and warrants
are calculated using the treasury stock method. However, ordinary share equivalents are not included in the denominator of the
diluted earnings per share calculation when inclusion of such shares would be anti-dilutive, such as in a period in which a net loss is
recorded.
<28>Segment reporting
The Group has one operating segment whose business is developing and operating online games and related services. The Group’s
chief operating decision maker is the chief executive officer, who reviews consolidated results when making decisions about
allocating resources and assessing performance of the Group. The Group generates its revenues from customers in the PRC, North
America and other areas.
<29> Certain risks and concentration
Financial instruments that potentially subject the Group to significant concentrations of credit risk consist primarily of cash and cash
equivalents, accounts receivable and prepayments and other current assets. As of December 31, 2014 and 2015, substantially all of
the Group’s cash and cash equivalents were held by major financial institutions, which management believes are of high credit
worthiness.
<30> Fair value measurements
Fair value is the price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between
market participants at the measurement date. When determining the fair value measurements for assets and liabilities required or
permitted to be recorded at fair value, the Company considers the principal or most advantageous market in which it would transact
and it considers assumptions that market participants would use when pricing the asset or liability. The fair value measurement
guidance provides a fair value hierarchy that requires an entity to maximize the use of observable inputs and minimize the use of
unobservable inputs when measuring fair value. A financial instrument’s categorization within the fair value hierarchy is based upon
the lowest level of input that is significant to the fair value measurement as follows:
F-27
Level 1 inputs are unadjusted quoted prices in active markets for identical assets that the management has the ability to access at the
measurement date.
Level 2 inputs include quoted prices for similar assets in active markets, quoted prices for identical or similar assets in markets that
are not active, inputs other than quoted prices that are observable for the asset (i.e., interest rates, yield curves, etc.), and inputs that
are derived principally from or corroborated by observable market data by correlation or other means (market corroborated inputs).
Level 3 inputs include unobservable inputs to the valuation methodology that reflect management’s assumptions about the
assumptions that market participants would use in pricing the asset. The management develops these inputs based on the best
information available, including their own data.
<31>Financial instruments
Financial instruments primarily consist of cash and cash equivalents, restricted cash, short-term investment, accounts receivable,
accounts payable, warrants, convertible notes, long-term accounts payable and long-term debt. The carrying value of the Group’s
cash and cash equivalents, restricted cash, short-term investment, accounts receivable and accounts payable approximate their market
values due to the short-term nature of these instruments. Warrants are recorded in the consolidated balance sheets based on fair value.
The carrying value of long-term accounts payable approximates its fair value as the impact to discount the long-term payable with
interest rate is insignificant. The carrying value of long-term debt approximates its fair value as its interest rates is at the same level of
the current market yield for comparable loans. The carrying value of convertible notes as of December 31, 2015 was RMB129.3
million (US$20.0 millions) and the fair value of the convertible notes was approximately RMB193.5 million (US$29.8 million) as of
December 31, 2015.
<32> Recent accounting pronouncements
In May 2014, the Financial Accounting Standards Board (FASB) issued an accounting standard update on revenue recognition that
will be applied to all contracts with customers. The update requires an entity to recognize revenue when it transfers promised goods
or services to customers in an amount that reflects what it expects in exchange for the goods or services. It also requires more detailed
disclosures to enable users of financial statements to understand the nature, amount, timing and uncertainty of revenue and cash flows
arising from contracts with customers. In August 2015, the FASB issued ASU No. 2015-14, deferring the effective date for ASU
2014-09 by one year, and thus, the new standard will be effective for fiscal years beginning after December 15, 2017, with early
application permitted only as of annual reporting periods beginning after December 15, 2016, including interim reporting periods
within that reporting period. The guidance allows for either a full retrospective or a modified retrospective transition method. The
Company is currently assessing the impact that the guidance will have on the Company’s financial condition and results of
operations.
F-28
In February 2015, the FASB issued ASU 2015-02 to respond to stakeholders ‘concerns about the current accounting for consolidation
of certain legal entities. Stakeholders expressed concerns that current generally accepted accounting principles (GAAP) might require
a reporting entity to consolidate another legal entity in situations in which the reporting entity’s contractual rights do not give it the
ability to act primarily on its own behalf, the reporting entity does not hold a majority of the legal entity’s voting rights, or the
reporting entity is not exposed to a majority of the legal entity’s economic benefits or obligations. Financial statement users asserted
that in certain of those situations in which consolidation is ultimately required, deconsolidated financial statements are necessary to
better analyze the reporting entity’s economic and operational results. Previously, the FASB issued an indefinite deferral for certain
entities to partially address those concerns. However, the amendments in this Update rescind that deferral and address those concerns
by making changes to the consolidation guidance. The ASU is effective for fiscal years beginning after December 15, 2016, and
interim periods thereafter. Early adoption is permitted. The Group is in the process of evaluating the impact of the standard on its
consolidated financial statements.
In April 2015, the FASB issued ASU 2015-03 to simplify presentation of debt issuance costs, which requires that debt issuance costs
related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt
liability, consistent with debt discounts. The recognition and measurement guidance for debt issuance costs are not affected by the
amendments. The ASU is effective for fiscal years beginning after December 15, 2016, and interim periods thereafter. Early adoption
is permitted. The Group early adopted this guidance as of December 31, 2015. The adoption of this guidance did not have a material
effect on the Company’s financial condition, results of operations and cash flows.
In May 2015, the FASB issued ASU 2015-07, Topic 820, and Fair Value Measurement, which permits a reporting entity, as a
practical expedient, to measure the fair value of certain investments using the net asset value per share of the investment. Currently,
investments valued using the practical expedient are categorized within the fair value hierarchy on the basis of whether the
investment is redeemable with the investee at net asset value on the measurement date, never redeemable with the investee at net asset
value, or redeemable with the investee at net asset value at a future date. For investments that are redeemable with the investee at a
future date, a reporting entity must take into account the length of time until those investments become redeemable to determine the
classification within the fair value hierarchy.
In November 2015, the FASB issued ASU 2015-17, to simplify the presentation of deferred income taxes, which requires that
deferred tax liabilities and assets be classified as noncurrent in a classified statement of financial position. The amendments in this
Update apply to all entities that present a classified statement of financial position. The current requirement that deferred tax
liabilities and assets of a tax-paying component of an entity be offset and presented as a single amount is not affected by the
amendments in this Update. The Group has adopted this guidance during the year ended December 31, 2015 with a retroactive
application. The adoption of this guidance did not have a material effect on the Company’s financial condition, results of operations
and cash flows.
F-29
In January 2016, the FASB issued ASU 2016-01, to improve and to achieve convergence of their respective standards on the accounting
for financial instruments and enhance the reporting model for financial instruments to provide users of financial statements with more
decision-useful information. The amendments in this Update address certain aspects of recognition, measurement, presentation, and
disclosure of financial instruments. The Board also is addressing measurement of credit losses on financial assets in a separate project.
For public business entities, the amendments in this Update are effective for fiscal years beginning after December 15, 2017, including
interim periods within those fiscal years. The adoption of this guidance did not have a material effect on the Company’s financial
condition, results of operations and cash flows.
In February 2016, the FASB issued ASU 2016-02, to increase transparency and comparability among organizations by recognizing lease
assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements. The ASU is effective for
fiscal years beginning after December 15, 2016, and interim periods thereafter. Early adoption is permitted. The Group is in the process
of evaluating the impact of the standard on its consolidated financial statements.
In March 2016, the FASB issued ASU 2016-06, which clarifies the requirements for assessing whether contingent call (put) options that
can accelerate the payment of principal on debt instruments are clearly and closely related to their debt hosts. An entity performing the
assessment under the amendments in this Update is required to assess the embedded call (put) options solely in accordance with the
four-step decision sequence. For public business entities, the amendments in this Update are effective for financial statements issued for
fiscal years beginning after December 15, 2016, and interim periods within those fiscal years. An entity should apply the amendments in
this Update on a modified retrospective basis to existing debt instruments as of the beginning of the fiscal year for which the
amendments are effective. Early adoption is permitted, including adoption in an interim period. If an entity early adopts the amendments
in an interim period, any adjustments should be reflected as of the beginning of the fiscal year that includes that interim period. The
Group is in the process of evaluating the impact of adoption of this guidance on the consolidated financial statements.
In March 2016, the FASB issued ASU 2016-07, which eliminates eliminate the requirement to retroactively adopt the equity method of
accounting. The amendments require that the equity method investor add the cost of acquiring the additional interest in the investee to
the current basis of the investor’s previously held interest and adopt the equity method of accounting as of the date the investment
becomes qualified for equity method accounting. The amendments in this Update are effective for all entities for fiscal years, and
interim periods within those fiscal years, beginning after December 15, 2016. The amendments should be applied prospectively upon
their effective date to increases in the level of ownership interest or degree of influence that result in the adoption of the equity method.
Earlier application is permitted. The Group is in the process of evaluating the impact of adoption of this guidance on the consolidated
financial statements.
In March 2016, the FASB issued ASU 2016-09, which simplifies several aspects of the accounting for employee share-based payment
transactions for both public and nonpublic entities, including the accounting for income taxes, forfeitures, and statutory tax withholding
requirements, as well as classification in the statement of cash flows. For public entities, the ASU is effective for annual reporting
periods beginning after December 15, 2016, including interim periods within those annual reporting periods. Early adoption will be
permitted in any interim or annual period for which financial statements have not yet been issued or have not been made available for
issuance. The Group is in the process of evaluating the impact of adoption of this guidance on the consolidated financial statements.
3. CONVENIENCE TRANSLATION
The Group, with the exception of its subsidiary, Red 5, The9 Interactive, Red 5 Singapore, Red5 Korea and The9 Korea, maintains its
accounting records and prepares its financial statements in RMB. The United States dollar (“US dollar” or “US$”) amounts disclosed in
the accompanying financial statements are presented solely for the convenience of the readers at the rate of US$1.00 = RMB6.4778,
representing the noon buying rate in the City of New York for cable transfers of RMB, as certified for customs purposes by the Federal
Reserve Bank of New York, on December 31, 2015. Such translations should not be construed as representations that the RMB amounts
represent, or have been or could be converted into, United States dollars at that or any other rate.
4. VARIABLE INTEREST ENTITIES
The Group is the primary beneficiary of certain VIEs, including i) Shanghai IT which was designed by the Group to comply with PRC
regulations that prohibit direct foreign ownership of businesses that operate online games in the PRC and ii) Mengxiang Hulian, which
is a start-up research and development company (“R&D VIE”) developing games and software funded by the Group. Due to the weaker
than expected performance of the game developed by Mengxiang Hulian, the Group has stopped funding Mengxiang Hulian and it had
become an inactive company as of December 31, 2014.
Shanghai Huopu Cloud Computing Terminal Technology Co., Ltd. (“Huopu Cloud”) was considered as an VIE of the Group since its
establishment in 2010. In 2014, the Group sold Houpu Cloud to a third party (Note 32).
F-30
Shanghai IT
Shanghai IT was designed by the Group to comply with PRC regulations that prohibit direct foreign ownership of businesses that
operate online and TV games in the PRC.
There are a few key contractual arrangements between the Group’s subsidiary, The9 Computer (the “WOFE”) and respective VIEs
that provide the Group with a controlling financial interest over the VIEs and upon which the Group concluded that it is required to
consolidate these entities pursuant to the guidance in ASC 810.
A summary of the contractual agreements referenced above is as follows:
1)
2)
Loan Agreement. The WOFE entered into loan agreements with each shareholder of the relevant VIEs. Pursuant to the
terms of these loan agreements, the WOFE granted an interest-free loan to each shareholder of the VIEs for the explicit
purpose of making a capital contribution to the VIEs. The loans have an unspecified term and will remain outstanding for
the duration of WOFE or until such time that the WOFE elects to terminate the agreement (which is at the WOFE’s sole
discretion) at which point the loans are payable on demand. The shareholders of the VIEs may not prepay all or any
portion of the loans without the WOFE’s prior written request.
Equity Pledge Agreement. The shareholders of the VIEs entered into equity pledge agreements with the WOFE. Under the
equity pledge agreements, the shareholders of the VIEs pledged all of their equity interests in the VIEs to the WOFE as
collateral for all of their payments due to the WOFE and to secure performance of all obligations of the VIEs and their
shareholders under the above loan agreements. In addition, the dividend distributions to the shareholders of VIEs, if any,
will be deposited in an escrow account over which the WOFE has exclusive control. The pledge shall remain effective
until all obligations under such agreements have been fully performed. The shareholder has the obligation to maintain
ownership and effective control over the pledged equity. Under no circumstances, without the prior written consent of the
WOFE, may the shareholder transfer or otherwise encumber any equity interests in the VIEs. If any event of default as
provided for therein occurs, the WOFE, as the pledgee, will be entitled to dispose of the pledged equity interests through
transfer or assignment and use the proceeds to repay the loans or make other payments due under the above loan
agreements up to the loan amounts.
F-31
3) Call Option Agreement. The VIEs and their shareholders entered into equity call option agreements with the WOFE.
Pursuant to such agreements, the shareholders of the VIEs grant the WOFE an irrevocable and exclusive option to
purchase the shares of VIEs at a purchase price equal to the amount of the registered capital of the VIE or the loan
provided by the WOFE, permissible by the then-applicable PRC laws and regulations. WOFE may exercise such right at
any time during the term of the agreement. Moreover, under the call option agreements, neither the VIEs nor their
shareholders may take actions that could materially affect the VIEs’ assets, liabilities, operations, equity or other legal
rights without the prior written approval of the WOFE, including, without limitation, declaration and distribution of
dividends and profits; sale, assignment, mortgage or disposition of, or encumbrances on, the VIE’s equity; merger or
consolidation; acquisition of and investment in any third-party entities; creation, assumption, guarantee or incurrence of
any indebtedness; entering into other materials contracts. The agreements shall not expire until such time as the WOFE
acquires all equity interests of the relevant VIEs subject to applicable PRC laws.
4)
5)
Shareholder Voting Proxy Agreement. Each of the VIE’s shareholders executed an irrevocable power of proxy to appoint
the WOFE as the attorney-in-fact to act on his or her behalf on all matters pertaining to the VIEs and to exercise all of his
or her rights as a shareholder of the VIEs, including the right to attend shareholders meetings, to exercise voting rights and
to appoint directors, a general manager, and other senior management of the VIEs. The power of proxy is irrevocable and
may only be terminated at the discretion of the WOFE.
Exclusive Technical Service Agreement. Under the exclusive technical service agreement, the VIEs agreed to engage the
WOFE as their exclusive provider of technology consulting and other services for a service fee equal to 90% of all
operating profit generated by the VIEs. According to the relevant PRC rules and regulations, related party transactions
should be negotiated at the arm’s length basis and apply reasonable transfer pricing methods. However, the determination
of service fees is under the sole discretion of the WOFE. These agreements do not have specific clauses on renewal but do
have an initial term of 20 years (with the earliest expiration date being December 31, 2029). By virtue of the governance
rights the WOFE maintains over the VIEs, through the terms of the other agreements noted above, the Group is able to
unilaterally renew, extend or amend the service agreements at its discretion.
The Group shall be deemed to have a controlling financial interest in a VIE if it has both of the following characteristics:
a. The power to direct the activities of a VIE that most significantly impact the VIE’s economic performance; and
b. The obligation to absorb losses of the VIE that could potentially be significant to the VIE or the right to receive benefits from
the VIE that could potentially be significant to the VIE.
F-32
In determining the Group has “the power to direct the activities of the VIE that most significantly impact the VIEs’ economic
performance,” the Group looked to the specific provisions of the Call Option Agreement and Shareholder Voting Proxy Agreement.
These agreements, as summarized above, provide the WOFE effective control over all of the corporate and operating decisions of the
VIEs, and as such, the Group’s management concluded that the WOFE has the requisite power to direct the activities of the VIEs that
most significantly impact the VIEs’ economic performance. In assessing the Group’s obligation to absorb losses, the Group notes that
it has funded through the loan agreements all of the entities’ share capital and also provides financial support as necessary to the
entities through intercompany transactions. The Group’s rights to receive economic benefits that are significant to the VIEs are
embodied firstly in the Equity Pledge Agreements that secure the equity owners’ obligations under the relevant agreements, and
ascribes to the WOFE all of the economic benefits of the equity interests including rights to any dividends declared. Secondly, the
Exclusive Technical Service Agreement further secures the ability of WOFE to receive substantially all of the economic benefits from
each of the VIEs on behalf of the Group.
In conclusion, because the Group, through its wholly owned subsidiary The9 Computer, has (1) the power to direct the activities of
the VIEs that most significantly affect the VIE’s economic performance and (2) the right to receive benefits from the VIEs that could
potentially be significant to the VIEs, it has been deemed to be the primary beneficiary of the VIEs and has consolidated the
respective VIEs since the date of execution of such agreements.
Shareholders of the VIEs may potentially have conflicts of interest with the Company, and they may breach their contracts with the
PRC subsidiaries or cause such contracts to be amended in a manner contrary to the interests of the Company. As a result, the
Company may have to initiate legal proceedings, which involve significant uncertainty. Such disputes and proceedings may
significantly disrupt the Company’s business operations and adversely affect the Company’s ability to control the VIEs. In light of the
fact that most of the shareholders of the VIEs are directors, officers, shareholders or employees of the Company or the PRC
subsidiaries, management is of the view that the risk that misaligned interests may lead to deconsolidation in the foreseeable future is
remote and insignificant.
F-33
PRC laws and regulations currently limit foreign ownership of companies that provide Internet content services, which include
operating online games. In addition, foreign invested enterprises are currently not eligible to apply for the required licenses for
operating online games in the PRC. The Company is incorporated in the Cayman Islands and is considered a foreign entity under the
PRC laws. Due to restrictions on foreign ownership of the provision of online games, the Company is dependent on the licenses held
by Shanghai IT to conduct its online games business through its subsidiary in the PRC. Shanghai IT holds the necessary licenses and
approvals that are essential for the online game business. The9 Computer has entered into contractual arrangements with Shanghai IT
for use of its relevant licenses and websites. Shanghai IT is principally owned by certain shareholder and employee of the Company.
Pursuant to certain other agreements and undertakings, the Company in substance controls Shanghai IT. In the opinion of the
Company’s directors, the Company’s current ownership structures and its contractual arrangements with Shanghai IT, and its equity
owners as well as its operations, are in compliance with all existing PRC laws and regulations. However, there may be changes and
other developments in the PRC laws and regulations or their interpretation. Specifically following the recent promulgation of the
GAPP Circular, it is unclear whether the authorities will deem our VIE structure and contractual arrangements with Shanghai IT as an
“indirect or disguised” way by foreign investors to gain control over or participate in domestic online game operators, and challenge
our VIE structure accordingly. If the Company, its PRC subsidiaries and VIEs are found to be in violation of any existing or future
PRC laws or regulations, or fail to obtain or maintain any of the required permits or approvals, the relevant PRC regulatory
authorities would have broad discretion in dealing with such violations, including requiring the Company to undergo a costly and
disruptive restructuring such as forcing the Company to transfer its equity interest in the PRC subsidiaries to a domestic entity or
invalidating the VIE agreements. If the PRC government authorities impose penalties which cause the Company to lose its rights to
direct the activities of and receive economic benefits from the VIEs, the Company may lose the ability to consolidate and reflect in its
financial statements the financial condition, and results of operation of the VIEs.
The Group has concluded that the aforementioned contractual arrangements are legally enforceable and provide the Group with full
control of the VIEs. However, the aforementioned contractual arrangements with the VIEs and their respective shareholders are
subject to risks and uncertainties:
•
The VIEs or their shareholders could fail to obtain the proper operating licenses or fail to comply with other regulatory
requirements. As a result, the PRC government could impose fines, new requirements or other penalties on the VIEs or the
Group, mandate a change in ownership structure or operations for the VIEs or the Group, restrict the VIEs or the Group’s
use of financing sources or otherwise restrict the VIEs or the Group’s ability to conduct business.
•
The aforementioned contractual agreements may be unenforceable or difficult to enforce. The equity pledge agreements
may be deemed improperly registered or the VIEs or the Group may fail to meet other requirements. Even if the
agreements are enforceable, they may be difficult to enforce given the uncertainties in the PRC legal system.
•
•
The PRC government may declare the aforementioned contractual agreements invalid. They may modify the relevant
regulation, have a different interpretation of such regulations, or otherwise determine that the Group or the VIEs have
failed to comply with the legal obligations required to effectuate such contractual arrangements.
It may be difficult to finance the VIEs by means of loans or capital contributions. Loans from our offshore parent company
to the VIEs must be approved by the relevant PRC government body and such approval may be difficult or impossible to
obtain. Because the VIEs are domestic PRC enterprises owned by nominee shareholders, the Group is not likely to finance
their activities by means of direct capital contributions either.
F-34
If the Company, its PRC subsidiaries and VIEs are found to be in violation of any existing or future PRC laws or regulations, or fail
to obtain or maintain any of the required permits or approvals, the relevant PRC regulatory authorities would have broad discretion in
dealing with such violations, including requiring the Company to undergo a costly and disruptive restructuring such as forcing the
Company to transfer its equity interest in the PRC subsidiaries to a domestic entity or invalidating the VIE agreements. If the PRC
government authorities impose penalties which cause the Company to lose its rights to direct the activities of and receive economic
benefits from the VIEs, the Company may lose the ability to consolidate and reflect in its financial statements the results of operation
of the VIEs. The Company, however, does not believe such actions would result in the liquidation or dissolution of the Company, the
WOFEs or VIEs.
R&D VIE
Mengxiang Hulian is a primarily start-up research and development company developing games and software funded by the Group
starting from 2011. The Group had arrangements with Mengxiang Hulian (the “R&D” company) pursuant to which the Group
provided substantial financial support and obtained equity interests in these entities. The Group has acquired or has an option to
acquire the exclusive licenses in Mainland China or worldwide for the games and software under development by these entities. As of
December 31, 2014 and 2015, the Group held equity interest of 20% of Mengxiang Hulian.
Under the above arrangements with the R&D company, the Group has the power to make decisions that most significantly affect the
entities’ operations and effectively assumed a majority of economic risks associated with these entities, and has the obligation to
absorb losses and the right to receive returns that are significant to these entities. As such, prior to the reconsideration events
discussed below, it was determined that the Group is the primary beneficiary of these entities and has included them in its
consolidated financial statements since their respective dates of incorporation.
Summary financial information of the VIE subsidiaries included in the accompanying consolidated financial statements with
intercompany balances and transactions eliminated are as follows:
Total assets
Total liabilities
December 31,
2014
RMB
December 31,
2015
RMB
December 31,
2015
US$ (Note 3)
130,055,790 141,614,244
231,634,266 222,151,400
21,861,472
34,294,267
F-35
Net Revenue
Net profit (loss)
December 31,
2013
RMB
December 31,
2014
RMB
December 31,
2015
RMB
December 31,
2015
US$ (Note 3)
86,574,297
42,697,861 34,390,944 5,309,047
(201,412,786) 101,628,848 (95,285,846) (14,709,600)
The VIEs contributed an aggregate of 82.6%, 66.4% and 74.1% of the consolidated net revenues for the years ended December 31,
2013, 2014 and 2015, respectively. The Company’s operations not conducted through contractual arrangements with the VIE
primarily consist of its product development on Firefall in the United States. As of the fiscal years ended December 31, 2014 and
2015, the VIEs accounted for an aggregate of 25.1% and 26.3%, respectively, of the consolidated total assets, and 72.2% and 37.0%,
respectively, of the consolidated total liabilities.
There are no consolidated VIE’s assets that are collateral for the VIE’s obligations and can only be used to settle the VIE’s
obligations.
Relevant PRC laws and regulations restrict the VIE from transferring a portion of its net assets, equivalent to the balance of its
statutory reserve and its share capital, to the Company in the form of loans and advances or cash dividends. Please refer to Note 29
for disclosure of restricted net assets.
F-36
5. PREPAYMENTS AND OTHER CURRENT ASSETS
Prepayments and other current assets are as follows:
Receivable from a former equity method investee
Consideration receivable for a disposal of a subsidiary
Receivable from a supplier (Note 14)
Prepayments and deposits
Employee advances
Others
December 31,
2014
RMB
December 31,
2015
RMB
4,500,000
12,750,575
17,927,763
10,929,101
1,963,858
8,502,024
56,573,321
—
—
—
3,220,205
2,717,027
3,525,917
9,463,149
December 31,
2015
US$
(Note 3)
—
—
—
497,114
419,437
544,307
1,460,858
6. PREPAID ROYALTIES AND DEFERRED COSTS
Due to a weaker than expected operating performance of certain games, and the expectation that the net cash flow of these games will
not be sufficient to recover the carrying amount of the prepaid royalties, the Group recognized an impairment loss for prepaid
royalties associated with such games of RMB10.4 million, nil and nil for the years ended December 31, 2013, 2014, and 2015,
respectively, and an impairment loss for deferred cost of RMB2.7 million, nil and nil for the years ended December 31, 2013, 2014,
and 2015, respectively. The impairment charges of prepaid royalties and deferred cost were included in cost of services in the
consolidated statements of operations and comprehensive loss.
7. INVESTMENTS IN EQUITY INVESTEES
The Group’s investments in equity investees comprise the following:
Investments accounted for under equity method:
ZTE9 network technology Co., Ltd., Wuxi (“ZTE9”)
System Link Corporation Limited (“System Link”)<1>
Shanghai Jiucheng Advertisement Co., Ltd. (“Jiucheng Advertisement”) <2>
Investments accounted for under cost method:
Shanghai Institute of Visual Art of Fudan University (“SIVA”)
G10 Entertainment Corporation (“G10”) Ltd.
CrowdStar Inc. (“Crowdstar”)
Tandem Fund II, L.P. (“Tandem Fund”)
Total
F-37
December 31,
2014
RMB
December 31,
2015
RMB
December 31,
2015
US$ (Note 3)
67,020
—
—
— 215,631,351 33,287,744
— 12,751,438 1,968,483
10,000,000 10,000,000 1,543,734
24,892,921 24,892,921 3,842,805
251,181
1,627,099 1,627,099
2,636,885 2,636,885
407,065
39,223,925 267,539,694 41,301,012
<1> System Link
In August 2014, the Group formed a joint venture, System Link, with Qihoo 360 Technology Co., Ltd., or Qihoo 360. Pursuant to the
joint venture agreement, Qihoo 360 and the Group will each own 50% equity interest in the joint venture and share profits based on
the equity interest each party holds in the joint venture. In August 2014, Red 5 Singapore entered into a license agreement with
System Link for publishing and operating Firefall under a five-year term in mainland China. Under this license agreement, System
Link is expected to pay Red 5 Singapore no less than US$160 million (inclusive of license fee and royalties) during the term of the
agreement. The Group accounts for its investment in System Link as an equity method investment. The total capital contribution from
the Group is RMB 223.4 million (US$35 million) as of December 31, 2015. The Group records a loss of RMB 11.1 million (US$1.7
million) in share of loss in equity method and a gain of RMB3.3 million (US$0.5 million) in other comprehensive income for the year
ended December 31, 2015.
The Group has filed System Link Corporation Limited’s consolidated financial statement as indicated in our annual report on Form
20-F for the year ended December 31, 2015, as the 20% significant subsidiary test was met for the current year in accordance with
Rule 3-09 of SEC Regulation S-X.
<2> Jiucheng Advertisement
In June 2015, the Group granted 33.3% equity interest of Jiucheng Advertisement to two of its employees for nil consideration. The
Group recorded share-based compensation of RMB 2.7 million as a result of this transaction as the equity interest was considered a
share-based award for this service. In October, 2015, the Group entered into an agreement with Fei Fan Information Technology Co.,
Ltd. (“Fei Fan”), whereby Jiucheng Advertisement acquired 100% equity interest in Fei Fan in exchange of 30% equity interest in
Jiucheng Advertisement. Upon the completion of the exchange, the Group’s equity interest in Jincheng Advertisement was diluted to
46.7%. The Group accounted for the exchange as a disposal of subsidiary with a gain of RMB 3.3 million (US$0.5 million)
recognized upon disposal and an acquisition of an equity method investment in Jiucheng Advertisement at fair value. In November
2015, The Group’s equity interest in Jiucheng Advertisement was further diluted to 42% as a result of capital injection by other
shareholders.
In October 2014, the Group disposed to a third party, 100% of its equity interest in an equity method investee for a cash consideration
of RMB14 million and further recovered loan receivables of RMB9.8 million to the same equity method investee. The Company had
previously fully impaired the investment in 2013 as well as provided a full allowance for the loan receivables due to the tight liquidity
position combined with less than satisfactory performance of the investee. The Group recorded a gain of RMB23.8 as a result of this
disposal.
In 2014, the Group disposed 75% of its interest in Tandem Fund for cash consideration of RMB11.0 million, a gain of RMB3.1
million was recognized upon disposal.
The Group recorded impairment charges relating to its investment in equity investees of RMB41.7 million, nil and nil for the years
ended December 31, 2013, 2014 and 2015, respectively.
F-38
8. AVAILABLE-FOR-SALE INVESTMENTS
Investment in Youjia Group Limited (“Youjia”)
In November 2011, the Group acquired 925,926 redeemable and convertible preferred shares of Youjia, a mobile social application
developer based in the PRC, for a consideration of US$1.0 million. The Group’s investment represented 6.67% of Youjia’s equity
interest on an as converted basis as of December 31, 2011. The Group recorded the investment in Youjia as an available-for-sale
investment as the redeemable convertible preference share is in substance a debt security. During 2013, based on an evaluation of the
financial results and condition of Youjia, the Group provided full impairment provision of Youjia.
In April 2014, the Group disposed all of its shares in Youjia to a third party for a cash consideration of US$1.0 million
(RMB6.3 million), a gain of RMB6.3 million (US$1.0 million) for the year ended December 31, 2014 is recognized upon disposal.
9. PROPERTY, EQUIPMENT AND SOFTWARE, NET
Property, equipment and software and related accumulated depreciation and amortization are as follows:
Office buildings
Computer and equipment
Leasehold improvements
Office furniture and fixtures
Motor vehicles
Software
Less: accumulated depreciation and amortization
Net book value
F-39
December 31,
2014
RMB
December 31,
2015
RMB
67,881,751
123,158,909
12,571,448
10,395,482
11,092,117
18,175,695
(206,929,172)
36,346,230
69,276,652
118,052,297
11,008,880
11,355,064
10,889,632
18,424,967
(205,160,974)
33,846,518
December 31,
2015
US$
(Note 3)
10,694,472
18,224,134
1,699,478
1,752,920
1,681,070
2,844,325
(31,671,397)
5,225,002
Depreciation and amortization charges for the years ended December 31, 2013, 2014 and 2015 amounted to RMB19.0 million,
RMB15.7 million and RMB11.6 million (US$1.8 million) respectively. The office building was mortgaged for the convertible notes
and bank borrowing in year 2015 (Note 20 and 21).
Due to weaker than expected operating performance of certain games, the Group recognized impairment provisions on computer
equipment of RMB1.9 million, nil and nil in 2013, 2014, and 2015 respectively.
10. GOODWILL
The changes in the carrying amount of goodwill for the years ended December 31, 2013, 2014 and 2015 are as follows:
Balance at January 1, 2013
Translation difference
Balance at December 31, 2013
Translation difference
Balance at December 31, 2014
Translation difference
Balance at December 31, 2015
Balance at December 31, 2015 US$ (Note 3)
Gross
Amount
RMB
10,011,247
(300,393)
9,710,854
35,200
9,746,054
596,640
10,342,694
1,596,637
Accumulated
Impairment
Loss
RMB
—
—
—
—
—
—
—
—
Net Amount
RMB
10,011,247
(300,393)
9,710,854
35,200
9,746,054
596,640
10,342,694
1,596,637
In 2010, the Group recognized goodwill of RMB10.9 million in connection with the acquisition of Red 5. The Group measures the
consideration it transfers at fair value, which may be calculated as the sum of the acquisition-date fair values of the assets transferred,
liabilities incurred to former owners of the acquiree, and equity instruments issued. The costs directly attributable to the acquisition
are expensed as incurred. Identifiable assets acquired and liabilities assumed are measured separately at their fair value as of the
acquisition date, irrespective of the extent of any noncontrolling interests. Contingent consideration is measured at fair value and
recorded as a liability. The excess of (i) the total cost of acquisition, fair value of the noncontrolling interests and acquisition-date fair
value of any previously held equity interest in the acquiree over (ii) the fair value of the identifiable net assets of the acquiree is
recorded as goodwill. If the cost of acquisition is less than the fair value of the net assets of the subsidiary acquired, the difference
would be recognized directly in the consolidated statement of operations and comprehensive loss.
The Group performed annual impairment test on goodwill as of December 31, 2013, 2014 and 2015, respectively, as the fair value
was greater than carrying value of the reporting unit, no impairment was recorded.
F-40
11. INTANGIBLE ASSETS
Gross carrying amount, accumulated amortization and net book value of the intangible assets as of December 31, 2014 and 2015 are
as follows:
December 31,
2014
RMB
December 31,
2015
RMB
December 31,
2015
US$
(Note 3)
Acquired game licenses
Acquired game development cost
Less: Accumulated amortization
Impairment provision
Translation difference
Net book value of intangible assets subject to amortization
146,925,649 146,925,649 22,681,412
12,285,000 12,285,000 1,896,477
(55,738,585) (74,875,427) (11,558,774)
(678,376)
(164,308)
97,539,341 78,876,486 12,176,431
(4,394,381)
(1,064,355)
(4,394,381)
(1,538,342)
In 2014 and 2015, RMB1.8 million and nil acquired game licenses were expired, respectively, and were written off from the cost
basis and accumulated amortization.
Since its acquisition by the Group on April 6, 2010, Red 5 has been substantially devoting its operating activities to fulfill its
obligations under a game development and license agreement executed in 2006 and amended in 2009 between Red 5 and a third party
game publisher to develop Firefall in exchange for cash consideration from the third party publisher. Prior to the acquisition, Red 5
received a total of US$24.7 million cash consideration as an advance recoupable against future royalties payable to Red 5. Red 5
retained the ownership of the game and granted the third party publisher an exclusive, non-transferable term license to market and
distributes the game and host the game to customers in specified regions after Red 5 completes the game development. Red 5
continues to perform its obligations under the agreement post-acquisition, including the provision of post-contract customer support
for the hosted version of the game to the third party publisher during the term of the license. The initial term of the agreement is from
February 2006 through the fifth anniversary of the first commercial release of the initial game. Thereafter, the agreement can be
renewed in two-year terms.
F-41
In September 2011, Red5 Korea, Red 5 Singapore and Red5 entered into a series of agreements with the third party game publisher.
Pursuant to the agreement, Red 5 Singapore were substituted in full for the third party publisher as a party under the game
development and license agreement between Red 5 and the third party game publisher, including the exclusive , non-transferable term
license to market and distribute the game and host the game to customers in specified regions. Under the agreements, the Group paid
US$10.0 million and guaranteed an additional payment of US$12.7 million to the third party game publisher due within four years. In
addition, the Group is subject to additional contingent payments to be calculated based on certain percentages of the proceeds
received from future game licensing and royalties, if any. The total consideration paid, including the US$10 million and the
guaranteed amount of US$12.7 million, was recorded as acquired game license and the contingent payments will be recorded as cost
of services when incurred. The amount payable which is expected to due on or before December 31, 2016 amounted to US$ 3.1
million (RMB20.0 million) was recorded in accounts payable under current liabilities.
The Group pledged the intellectual property in relation to the game to secure the guaranteed amount. Following this license
acquisition, the previously recognized backlog of US$ 0.4 million in relation to the game development and license agreement
acquired in Red 5 acquisition was reclassified to acquire game licenses as it was considered to be additional cost to acquire the game
license paid in prior year.
Amortization expense related to intangible assets was RMB23.0 million, RMB28.9 million and RMB19.1 million (US$3.0 million)
for the years ended December 31, 2013, 2014 and 2015, respectively. As of December 31, 2015, the estimated aggregate amortization
expense from existing intangible assets for each of the five succeeding fiscal years is as follows:
2016
2017
2018
2019
2020
Total
RMB
21,964,146
21,964,146
21,964,146
12,984,048
—
78,876,486
US$
(Note 3)
3,390,680
3,390,680
3,390,680
2,004,391
—
12,176,431
The Group has been monitoring its licensed games that have not commercially launched, including but not limited to their market
acceptance and operational performance in other regions where they are commercially launched and operated by other operators. The
Group incorporates these factors into its continuous evaluation of the forecasted results of the respective games and taking into
account the Group’s expected commercial launch and cash flows in the evaluation of potential impairment of the carrying value of
upfront licensing fees. Based on the Group’s impairment tests, impairment provisions on upfront licensing fees of RMB3.8 million,
nil and nil were recognized in 2013, 2014 and 2015, respectively.
F-42
12. LAND USE RIGHT, NET
Gross carrying amount, accumulated amortization and net book value of land use right are as follows:
Land use right
Less: accumulated amortization
Net book value
December 31, 2014
December 31, 2015
RMB
RMB
85,160,348
(14,887,052)
70,273,296
85,160,348
(16,807,962)
68,352,386
December 31, 2015
US$
(Note 3)
13,146,492
(2,594,702)
10,551,790
Amortization charge for the years ended December 31, 2013, 2014 and 2015 amounted to RMB1.9 million, RMB1.9 million and
RMB1.9 million (US$0.3 million), respectively.
13. OTHER LONG-LIVED ASSETS
Other long-lived assets are as follows:
Receivable from WoW game points
refund agent (Note 19)
Others
Total
December 31, 2014
December 31, 2015
RMB
RMB
December 31, 2015
US$
(Note 3)
7,894,836
453,573
8,348,409
—
1,879,021
1,879,021
—
290,071
290,071
14. ALLOWANCE (REVERSAL OF ALLOWANCE) OF LONG-TERM RECEIVABLE
Allowance (reversal of allowance) of receivables 17,927,763
17,927,763
Total
(17,927,763)
(17,927,763)
—
—
—
—
December 31,
2013
RMB
December 31,
2014
RMB
December 31,
2015
RMB
December 31,
2015
US$
(Note 3)
F-43
The Group prepaid RMB20.0 million to a supplier for purchasing computers and equipment in 2011. Due to game’s performance
being much lower than expectations, the Group cancelled the purchase plan and requested for a refund on the prepayment from the
supplier in 2013. However, the supplier did not have enough funds to return all prepayment which was deemed a strong indicator that
recovery of the refund is doubtful. In February 2014, the Group agreed a repayment schedule with the supplier, under which the
prepayment is required to be refunded in four installments during the next three years, and the first installment, which was RMB2.0
million, had been received on March, 2014. Due to the significant doubts as to the collectability of the remaining amount,
management provided an allowance for the remaining prepayment receivable of RMB17.9 million as of December 31, 2013. The
Company continued to negotiate with the supplier for the settlement of remaining receivables. In December 2014, the supplier
promised to repay all the remaining RMB17.9 million before March 31, 2015. The Group revaluated the collectability of the
receivables and determined the payments can be collected and therefore reversed the allowance of RMB17.9 million as of December
31, 2014. In March, 2015, the Group received payment of RMB17.9 million from the supplier.
15. IMPAIRMENT ON PREPAYMENT FOR EQUIPMENT AND OTHER ASSETS
Impairment on prepayment for equipment and other
assets
Total
December 31,
2013
RMB
December 31,
2014
RMB
December 31,
2015
RMB
December 31,
2015
US$
(Note 3)
11,813,313
11,813,313
3,555,845
3,555,845
—
—
—
—
The Group prepaid RMB 11.8 million to a supplier for certain asset which was planned to be used in game promotion activity. In
2013, the management decided to change the game promotion plans and as a result the asset was no longer required under the new
promotion plan and as such Group decided not to take title to the asset from the supplier and wrote off the non-refundable
prepayment.
For the year ended December 31, 2014, the Group recorded RMB 3.6 million impairment on the prepayment to certain suppliers with
which the Group terminated the transaction and wrote off the repayment balance considering its low collectability.
16. FAIR VALUE MEASUREMENTS
Assets and Liabilities Measured at Fair Value on a Recurring Basis
The fair values of the common stock warrants were measured using the Black-Scholes option-pricing model (Note 22). Inputs used to
determine estimated fair value of the warrant liabilities include the estimated fair value of the underlying stock at the valuation date,
the estimated term of the warrants, risk-free interest rates, expected dividends and the expected volatility of the underlying stock. The
significant unobservable inputs used in the fair value measurement of the warrant liability are the fair value of the underlying stock at
the valuation date and the estimated term of the warrants. The fair value of convertible note is based on a discounted cash flow model
with an unobservable input of discount rate. (Level 3).
F-44
The Group measured the fair value of its investment in Youjia using the income approach based on a weighted average of multiple
discounted cash flow scenarios, which required the use of unobservable inputs (Level 3) including assumptions of projected revenue,
expenses, capital spending, and other costs, as well as a discount rate calculated based on the risk profile of the online game industry
and company-specific risk adjustments. The available-for-sale investment in Youjia was fully impaired in 2013 and then sold in 2014.
The following table presents the changes in the available-for-sale investment that were measured at fair value on a recurring basis
using significant Level 3 inputs for the year ended December 31, 2013, 2014 and 2015. The Group did not have other assets or
liabilities measured at fair value on a recurring basis using significant Level 3 inputs during the years ended December 31, 2013,
2014 and 2015.
Balance at the beginning of the year
Unrealized loss recognized in other
comprehensive income
Impairment losses included in earnings
Balance at the end of the year
Fair Value Measurements Using Significant Unobservable Inputs
(Level 3)
2013
RMB
6,285,500
(16,600)
(6,268,900)
—
2014
RMB
—
—
—
—
2015
RMB
—
—
—
—
In 2015, the Group issued warrants in connection with its convertible notes. The warrants are recorded at fair market value at the date
of issuance and subsequently at each reporting date. The following table presents the change in the warrants liability that were
measured at fair value on a recurring basis using significant Level 3 inputs during the year 2015 (Note 22).
Balance at issuance date
Unrealized loss recognized in other comprehensive income
Balance at the end of the year
2015
2015
RMB
57,285,780
7,129,161
64,414,941
US$ (Note 3)
8,843,400
1,100,553
9,943,953
Assets and Liabilities Measured at Fair Value on a Non-recurring Basis
The following table displays assets and liabilities measured at fair value on a non-recurring basis for the years ended December 31,
2013, 2014 and 2015, respectively.
Receivable from WoW game points refund
agent (Note 19)
Total
Year Ended
December 31,
2015
Fair Value Measurements at Reporting Date Using
Quoted Prices
in Active
Markets for
Identical Assets
(Level 1)
RMB
Significant
Other
Observable
Inputs
(Level 2)
RMB
Significant
Unobservable
Inputs
(Level 3)
RMB
Total
Losses (gains)
RMB
—
—
—
—
—
—
—
—
8,439,580
8,439,580
F-45
Year Ended
December 31,
2014
Quoted Prices
in Active
Markets for
Identical Assets
(Level 1)
RMB
Significant
Other
Observable
Inputs
(Level 2)
RMB
Significant
Unobservable
Inputs
(Level 3)
RMB
Prepayment for other assets (Note 15)
Total
—
—
—
—
—
—
—
—
Total
Losses (gains)
RMB
3,555,845
3,555,845
Fair Value Measurements at Reporting Date Using
Fair Value Measurements at Reporting Date Using
Year Ended
December 31,
2013
Quoted Prices
in Active
Markets for
Identical Assets
(Level 1)
RMB
Significant
Other
Observable
Inputs
(Level 2)
RMB
Significant
Unobservable
Inputs
(Level 3)
RMB
—
—
—
—
—
—
—
—
Total
Losses (gains)
RMB
11,813,313
17,927,763
29,741,076
Prepayment for equipment (Note 15)
Long-term receivables (Note 14)
Total
17. TAXATION
Cayman Islands and British Virgin Islands
Under the current tax laws of the Cayman Islands and British Virgin Islands, the Company and its subsidiaries are not subject to tax
on their income or capital gains. In addition, upon payment of dividends by the Company to its shareholders, no Cayman Islands
withholding tax will be imposed.
Hong Kong
The Group’s subsidiaries in Hong Kong did not have assessable profits that were derived in Hong Kong during the years ended
December 31, 2013, 2014 and 2015. Therefore, no Hong Kong profit tax has been provided for in the years presented.
F-46
Singapore
The Group’s subsidiaries in Singapore did not have assessable profits that were derived in Singapore during the years ended
December 31, 2013, 2014 and 2015. Therefore, no Singapore income tax has been provided for in the years presented.
The PRC
The Group’s subsidiaries and VIE subsidiaries in the PRC are subject to Enterprise Income Tax (“EIT”) on the taxable income as
reported in their respective statutory financial statements adjusted in accordance with the PRC Enterprise Income Tax Law (“EIT
Law”), which went into effect as of January 1, 2008. The Group’s subsidiaries and VIE subsidiaries in the PRC are generally subject
to EIT at a statutory rate of 25%. However, the subsidiaries that are located in the Pudong New District of Shanghai enjoy five-year
transitional EIT rates, which refer to the phase-in rates of 18%, 20%, 22%, 24% and 25% for the 5 years period from 2008 to 2012
and the subsidiaries that hold a “High and New Technology Enterprise” (“HNTE”) qualification are subject to a 15% preferential EIT
rate.
In November 2008, Shanghai IT received approval from certain government authorities to be qualified as a HNTE. This approval
entitles Shanghai IT to enjoy a 15% preferential EIT rate during the period from 2008 to 2010. The HNTE qualification is valid for
three years and every qualified HNTE company is required to re-apply for it in the three years after receiving approval. In October
2014, Shanghai IT renewed its HNTE qualification and obtained approval in 2015, which entitles Shanghai IT to enjoy a preferential
EIT rate of 15% during the period from 2014 to 2016. Total tax savings of Shanghai IT were nil for the years ended December 31,
2013, 2014 and 2015, respectively.
United States
The Group’s subsidiaries in the U.S. are registered in the state of California and are subject to U.S. federal corporate marginal income
tax rate of 34% and state income tax rate of 0.48%, respectively.
Composition of income tax expense
The current and deferred portions of income tax expense included in the consolidated statements of operations and comprehensive
loss are as follows:
2013
RMB
For the year ended December 31,
2014
RMB
2015
RMB
2015
US$
(Note 3)
Current income tax expense
China
Other jurisdictions
Deferred taxation
China
Other jurisdictions
Change in valuation allowance
China
Other jurisdictions
Income tax (expense) benefit
—
—
—
—
—
—
—
—
—
134,391,290 (21,011,979) 6,324,015
—
—
—
976,260
70,063,810 (62,051,840) (31,447,143) (4,854,602)
64,327,480 41,039,861 37,771,158 5,830,862
(976,260)
(70,063,810) 62,051,840 31,447,143 4,854,602
(64,327,480) (41,039,861) (37,771,158) (5,830,862)
—
(134,391,290) 21,011,979 (6,324,015)
—
—
—
F-47
Reconciliation of the differences between statutory tax rate and the effective tax rate
Reconciliation between the statutory EIT rate and the Group’s effective tax rate is as follows:
For the year ended
December 31, 2013
For the year ended
December 31, 2014
For the year ended
December 31, 2015
PRC Statutory EIT rate
Effect of different tax rates in other jurisdictions
Effect of future tax rate change
Change of prior year deferred tax assets
Change of valuation allowance
(Income) not subject to tax and non-deductible
expenses, net
Effect of expired net operating loss
Effective EIT rate
25%
(2%)
1%
1%
(24%)
0%
(1%)
0%
25%
10%
(1%)
(0%)
(16%)
2%
(20%)
(0%)
25%
(1%)
(1%)
(1%)
(2%)
(1%)
(19%)
0%
Significant components of deferred tax assets
Temporary differences related to expenses and accruals
Temporary differences related to provision for advances
to suppliers
Temporary differences related to provision for doubtful
accounts
Other
Temporary differences related to depreciation,
amortization, and impairment of equipment and
intangible assets
Startup expenses and advertising fee
Temporary differences related to research and
development credits
Temporary differences related to equity investment
Foreign tax credits
Temporary differences related to provision for
prepayment for equipment
Tax loss carry forwards
Total deferred tax assets
Less: Valuation allowance
Total deferred tax assets
F-48
December 31,
2014
RMB
December 31,
2015
RMB
December 31,
2015
US$
(Note 3)
1,926,262
3,285,994
507,271
1,621,968
888,961
137,232
191,012
5,609,163
1,510,153
5,900,763
233,126
910,921
11,710,677
25,761,300
12,728,642
26,010,125
1,964,964
4,015,271
988,010
1,795,745
15,113,930
1,045,470
1,531,567
16,039,192
161,393
236,433
2,476,025
5,000,000
492,204,751
561,922,818
(561,922,818)
—
5,000,000
505,784,660
579,725,527
(579,725,527)
—
771,867
78,079,697
89,494,200
(89,494,200)
—
Significant components of deferred tax liabilities
Temporary differences related to amortization of intangible assets
5,362,427 5,690,705
Movement of valuation allowance on deferred tax assets
December
31, 2014
RMB
December
31, 2015
RMB
December
31, 2015
US$
(Note 3)
878,494
For the year ended
December 31, 2014
For the year ended
December 31, 2015
RMB
RMB
Balance at January 1
Increase (decrease) in valuation allowance
Balance at December 31
582,934,797
(21,011,979)
561,922,818
561,922,818
17,802,709
579,725,527
For the year ended
December 31, 2015
US$
(Note 3)
86,745,935
2,748,265
89,494,200
For the years ended December 31, 2014 and 2015, a reversal of valuation allowance and an increase of valuation allowance of
approximately RMB21.0 million and RMB17.8 million (US$2.7 million) was provided respectively. The Group considers positive
and negative evidence to determine whether some portion or all of the deferred tax assets will more likely than not be realized. This
assessment considers, among other matters, the nature, frequency and severity of recent losses, forecasts of future profitability, the
duration of statutory carry forward periods, the Group’s experience with tax attributes expiring unused and tax planning alternatives.
Valuation allowances have been established for deferred tax assets based on a more-likely-than-not threshold. The Group’s ability to
realize deferred tax assets depends on its ability to generate sufficient taxable income within the carry forward periods provided for in
the tax law.
As of December 31, 2015, the Group’s PRC subsidiaries had net operating loss carry forwards of RMB817.1 million, of which
RMB162.9 million, RMB327.9 million, RMB190.2 million, RMB46.3 million and RMB89.8 million will expire in 2016, 2017, 2018,
2019 and 2020, respectively. The Group has provided a full valuation allowance as it is not more likely than not that the net operating
losses can be utilized before expiry.
F-49
As of December 31, 2015, Red 5 had net operating loss carry forwards for federal and state income tax purposes of approximately
US$124.2 million and US$68.7 million, respectively, which will begin to expire in 2026 and 2016, respectively. Red 5 also had
credits for increasing research activities available to offset future federal and state taxes payable of approximately US$0.1 million and
US$0.1 million, respectively, that will begin to expire in 2026 for federal purposes and which have no expiration for state purposes.
Red 5 had foreign tax credits for federal purposes of approximately US$2.5 million, which begin to expire in 2016. Pursuant to US
tax laws and regulations, the utilization of an acquired entity’s net operation losses and credits are subject to annual limitation
computed based on the fair value of the acquired entity. As a result of the limitation, the Group provided a full valuation allowance as
it is not more likely than not that the net operating losses and credits carried forward can be utilized before expiration.
In accordance with the Enterprise Income Tax Law (“EIT Law”), dividends, which arise from profits of foreign invested enterprises
(“FIEs”) earned after January 1, 2008, are subject to a 10% withholding income tax. In addition, under tax treaty between the PRC
and Hong Kong, if the foreign investor is incorporated in Hong Kong and qualifies as the beneficial owner, the applicable
withholding tax rate is reduced to 5%, if the investor holds at least 25% in the FIE, or 10%, if the investor holds less than 25% in the
FIE. A deferred tax liability should be recognized for the undistributed profits of PRC companies unless the Company has sufficient
evidence to demonstrate that the undistributed dividends will be reinvested and the remittance of the dividends will be postponed
indefinitely. The Group plans to indefinitely reinvest undistributed profits earned after December 31, 2007 from its China subsidiaries
in its operations in the PRC. Therefore, no withholding income taxes for undistributed profits of the Company’s subsidiaries have
been provided as of December 31, 2013, 2014 and 2015.
Under applicable accounting principles, a deferred tax liability should be recorded for taxable temporary differences attributable to
the excess of financial reporting basis over tax basis in a domestic subsidiary. However, recognition is not required in situations
where the tax law provides a means by which the reported amount of that investment can be recovered tax-free and the enterprise
expects that it will ultimately use that means. The Group has not recorded any such deferred tax liability attributable to the
undistributed earnings of its financial interests in VIEs because these entities do not have any accumulated earnings as of December
31, 2013, 2014 and 2015.
The Group made its assessment of the level of authority for each tax position (including the potential application of interests and
penalties) based on the tax positions’ technical merits, and measured the unrecognized benefits associated with the tax positions. The
Group did not have any unrecognized tax benefits as of December 31, 2013, 2014 and 2015. The Group does not anticipate that
unrecognized tax benefits will significantly increase or decrease within the next twelve months. For the years ended December 31,
2013, 2014 and 2015, the Group did not have any material interest and penalties associated with its tax positions.
F-50
According to PRC Tax Administration and Collection Law, the statute of limitations is three years if the underpayment of taxes is due
to computational errors made by the taxpayer or withholding agent. The statute of limitations will be extended five years under
special circumstances, which are not clearly defined (but an underpayment of tax liability exceeding RMB 0.1 million is specifically
listed as a special circumstance). In the case of a related party transaction, the statute of limitations is ten years. There is no statute of
limitations in the case of tax evasion. From inception to 2015, the Group is subject to examination of the PRC tax authorities. Red 5’s
federal income tax returns and state income tax returns for 2006 through 2015 are open tax years, subject to examination by the
relevant tax authorities.
18. ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES
Other payables and accruals are as follows:
Staff cost related payables
Professional services
Product development services
Marketing and promotion
Others
December
31, 2014
RMB
December
31, 2015
RMB
18,758,212
12,312,998
5,820,394
452,920
4,528,327
41,872,851
15,705,966
12,070,384
1,648,410
3,988
6,435,676
35,864,424
December
31, 2015
US$
(Note 3)
2,424,583
1,863,346
254,471
616
993,498
5,536,514
19. Refund of WoW game points
As a result of the loss of the WoW license on June 7, 2009, the Group announced a refund plan in connection with inactivated WoW
game point cards, which the Group recorded as advance from customers. According to the plan, inactivated WoW game point card
holders are eligible to receive a cash refund from the Group. The Group recorded a liability in connection with both inactivated points
cards and activated but unconsumed point cards of approximately RMB200.4 million, of which RMB4.0 million was refunded in
2009.
F-51
Upon the loss of the WoW license, the Group concluded the nature of the obligation substantively changed from deferred revenue, for
which the Group had the ability to satisfy the underlying performance obligation, to an obligation to refund players for their
unconsumed points. The Group has accounted for this refund liability by applying the derecognition guidance specified in ASC 405-
20. In accordance with this guidance, the refund liability associated with these WoW game points, to the extent not refunded, will be
recorded as other operating income after the Group is legally released from the obligation to refund amounts under the applicable
laws. In consultation with its legal counsel, the Group concluded the legal liability relating to the inactivated WoW game point cards
was extinguished in September 2011 on the basis that the legal liability lapsed two years from the date the Group publicly announced
the refund policy that applied to these cards. Accordingly, the associated liability amounting to RMB26.0 million (US$4.2 million)
was recognized as other operating income for the year ended December 31, 2011. With respect to the remaining refund liability,
based on current PRC laws, to the extent not refunded, the Company, in consultation with legal counsel has determined that it will be
legally released from this liability in September 2029, which represents 20 years from the discontinuation of WoW in 2009. However,
if the Group were to publicly announce a refund policy, the Group would be legally released from any remaining liability for these
activated, but unconsumed points that remained two years from the date of such announcement. To date, the Group has determined
not to publicly announce any refund policy with respect to this remaining liability, and no refunds have been claimed. The remaining
refund liability relating to the activated, but unconsumed WoW game points is RMB170.0 million (US$26.2 million) as of December
31, 2015.
In 2009, the Group engaged an agent to facilitate the refund to game players and provided an advance payment to the agent for
RMB43.3 million for this purpose. In 2013, 2014 and 2015, nil were refunded to game point card holders through the agent,
respectively. In February 2012, the Group entered into an agreement with the agent pursuant to which the agent will refund the
advance to the Group in installments over a five year period after deducting any further refunds paid to game point card holders. As
of December 31, 2015, the balance of the advance payment to the agent was RMB8.4 million (US$1.3 million). As of December 31,
2015, the Group wrote off the remaining RMB8.4 million receivable because it is unlikely that the agent will refund to us since the
business relationship between the Group and the agent have been terminated.
20. LONG-TERM DEBT
The Group entered an entrusted bank borrowing agreement, amounted to RMB 31.6 million (US$4.9 million), with a third party
investor and China Merchants Bank as entrustment bank. The borrowing is due in November 2018, with two years extension and
bears an annual interest rate of 12% due up maturity of the loan. The loan is secured by the real property of the office building of the
Group. The balance as of December 31, 2015 is RMB 31.7 million (US$ 4.9 million) also includes RMB 0.1 million (US$ 0.02
million) interest payable.
F-52
21. CONVERTIBLE NOTES
On November 24, 2015, the Group entered into agreement with a third party investor for a private placement of secured convertible
notes and warrants for a gross proceeds of US$40,050,000, which the transaction closed on December 11, 2015. Pursuant to the terms
of the agreement, the convertible notes mature in 2018, subject to an extension for two years at the discretion of the investor. The
convertible notes accrue interest at a rate of twelve percent (12%) per annum and payable upon maturity of the notes. The notes are
secured by the equity interest of the Group’s subsidiaries (The9 Computer and C9I Shanghai) and office buildings with a total net
book value of RMB24.3 million. The investor of the notes is entitled to put the notes to the Group upon a change in control and upon
an event of default.
The notes are divided into three tranches and can be converted into a total of 11,695,513 shares of the Group’s ADS at any time as
follows:
Convertible Note
Tranche A
Tranche B
Tranche C
Principle Amount Conversion Price
US$2.6
US$5.2
US$7.8
US$22,250,000
US$13,350,000
US$4,450,000
The conversion prices are subject to anti-dilution adjustments and in the event the Company issue ordinary shares at a price per share
lower than the applicable conversion price in effect immediately prior to the issuance. As of December 31, 2015, no adjustments to
the conversion prices had occurred.
The Group has determined that there was BCF attributable to Tranche A convertible loan as the conversion price is lower than market
value at the date of issuance of the convertible note. The value of the BCF is determined to be US$8.1 million (RMB 52.7 million),
which is equal to the intrinsic value of the conversion feature. The convertible notes are recorded at net carrying value at the date of
issuance as follows:
Principle Amount
Less:
Fair value allocated to warrants (Note 22)
Beneficial conversion feature
Issuance Cost
Net carrying value
US$
40,050,000
RMB
260,068,680
8,821,883
8,112,556
3,200,000
19,915,561
57,285,780
52,679,692
20,779,520
129,323,688
The fair value of warrants, BCF and issuance costs are recorded as debt discount and accreted to interest expense over 3 years using
the effective interest method. As of December 31, 2015, the carrying amount of the convertible notes is RMB 131.9 million (US$
20.3 million) and interest payable is RMB 3.3 million(US$0.5 million). Interest expense recognized related to the convertible note is
RMB 5.9 million (US$ 0.9 million) for the year ended December 31, 2015.
F-53
22. WARRANTS
The warrants issued in conjunction with the convertible notes expire November 24, 2020 and are exercisable at any time after the
commitment date to purchase up to 4,778,846 shares of the Company’s ADS as follows:
Warrants
Tranche I
Tranche A
Tranche B
Tranche C
Principle Amount
US$5,000,000
US$2,750,000
US$1,650,000
US$550,000
Exercise Price
US$1.5
US$2.6
US$5.2
US$7.8
The exercise prices of the warrants are subject to anti-dilution adjustments and in the event the Company issue ordinary shares at a
price per share lower than the applicable exercise price in effect immediately prior to the issuance. As of December 31, 2015, no
adjustments to the exercise prices had occurred.
The Group performs valuations of the warrants using a probability weighted Black-Scholes option pricing model. This model requires
input of assumptions including the risk-free interest rates, volatility, expected life and dividend rates, and has also considered the
likelihood of “down-round” financings. Selection of these inputs involves management’s judgment and may impact net income.
The assumptions used in the Black-Scholes option pricing model for the warrants were as follows:
Risk-free interest rate
Expected volatility of common stock
Dividend yield
Expected life of warrants
1.71%
63.25%
0.00%
5 years
The fair value of the warrants as of issuance date and December 31, 2015 is RMB 57.3 million (US$8.8 million) and RMB 64.4
million (US$9.9 million), respectively. The change in fair value of the warrant liability resulted in a loss of RMB 7.1 million (US$1.1
million) for the year ended December 31, 2015.
23. SHARE REPURCHASE PROGRAM
In December 2012, the Company’s Board approved share buyback of up to US$10 million of its ADSs over the next 12 months.
Under this share repurchase program, the Company spent an aggregate purchase consideration of approximately US$0.1 million and
repurchased approximately 0.04 million shares of its ADSs during the year ended December 31, 2012. During the year ended
December 31, 2013, the Company spent approximately US$4.6 million and repurchased approximately 1.7 million shares of ADSs.
F-54
24. SHAREHOLDER RIGHTS PLAN
On January 8, 2009, the Company adopted a shareholder rights plan. The shareholder rights plan is designed to protect the best
interests of the Company and its shareholders by discouraging third parties from seeking to obtain control of the Company in a tender
offer or similar hostile transaction. The shareholder rights plan was amended on March 9, 2009.
Pursuant to the terms of the shareholder rights plan, as amended, one right was distributed with respect to each ordinary share of the
Company outstanding at the close of business on January 22, 2009. The rights will become exercisable only if a person or group (the
“Acquiring Person”) obtains ownership of 15% or more of the Company’s voting securities (including by acquisition of the
Company’s ADSs representing ordinary shares) (a “Triggering Event”), subject to certain exceptions. In the case of a Triggering
Event, the rights plan entitles shareholders other than the Acquiring Person to purchase, for an exercise price of US$19.50, a number
of shares with a value twice that of the exercise price. The number of shares each such shareholder will be entitled to purchase is
equal to the product of (i) the number of shares then owned by such shareholder and (ii) two times the exercise price divided by the
then current market price per share. The rights plan will continue in effect until January 8, 2019, unless the plan is terminated by the
Company or the rights are redeemed by the Company before the plan expires. The plan has not been exercisable yet.
25. EMPLOYEE BENEFITS
The full-time employees of the Company’s subsidiaries and VIE subsidiaries that are incorporated in the PRC are entitled to staff
welfare benefits, including medical care, welfare subsidies, unemployment insurance and pension benefits through a PRC
government-mandated multi-employer defined contribution plan. These companies are required to accrue for these benefits based on
certain percentages of the employees’ salaries in accordance with the relevant regulations, and to make contributions to the state-
sponsored pension and medical plans out of the amounts accrued for medical and pension benefits. The total amounts charged to the
consolidated statements of operations and comprehensive loss for such employee benefits amounted to RMB15.3 million, RMB19.5
million and RMB13.1 million (US$2 million) for the years ended December 31, 2013, 2014 and 2015, respectively. The PRC
government is responsible for the medical benefits and ultimate pension liability to these employees.
26. SHARE-BASED COMPENSATION
26.1 Share Option Plan
On December 15, 2004, in connection with its initial public offering, the Company adopted a share option plan (“2004 Option Plan”).
As of December 31, 2013, the total number of ordinary shares reserved in the 2004 Option Plan was 6,449,614 shares. The maximum
contractual term of the awards under this plan shall be no more than five years from the date of grant. The options granted under this
plan shall be at the money on the date of grant and typically vest over a three-year period, with one third of the options to vest on the
each of the anniversary after the grant date. The 2004 Option Plan was amended in November 2015 to increase the maximum
aggregate number of ordinary shares to 14,449,614 Shares. As of December 31, 2015, options to purchase 12,877,718 ordinary shares
were outstanding and options to purchase 120,925 ordinary shares were available for future grant under the 2004 Option Plan.
F-55
Stock Options
The following table summarizes the Company’s share option activities with its employees and directors:
Outstanding at January 1, 2015
Granted
Exercised
Forfeited
Outstanding at December 31, 2015
Vested and expected to vest at December 31, 2015
Exercisable at December 31, 2015
Weighted-
Average
Exercise
Price
Weighted-
Average
Remaining
Contractual
Term
(years)
Aggregate
Intrinsic Value
US$2.41
1.03
—
US$4.52
US$1.53
US$1.53
US$1.53
4.41
4.41
4.42
US$7,577,903
US$7,577,903
US$4,998,364
Number of
Options
3,070,491
1,910,000
—
(302,773)
4,677,718
4,677,718
3,085,410
The options expected to vest are estimated by applying the pre-vesting forfeiture rate assumptions to total unvested options. The total
intrinsic value of options exercised during the year was US$119,624, US$21,701 and nil for year ended December 31, 2013, 2014
and 2015, respectively.
The weighted-average grant-date fair value of options granted during the years 2013 and 2015 was US$0.99 and US$0.65,
respectively. No options were granted during 2014. The fair value of the share options were measured on the respective grant dates
based on the Black-Scholes option pricing model, with below assumptions made regarding expected term and volatility, risk-free
interest rate and dividend yield:
F-56
Risk-free interest rate
Expected life (years)
Expected dividend yield
Volatility
Fair value of options at grant date
For the year
ended
December
31, 2013
0.35%
3.25
0
59.39%
For the year
ended
December
31, 2015
1.22%
3.35
0
59.74%
US$ 0.99
US$ 0.65
On November 17, 2015, The Group granted three tranches of share options to certain directors, officers and key employees totaling
8,200,000 shares with predetermined market conditions as summarized below:
Options
Tranche I
Tranche II
Tranche III
Total
Target Price
(US$)
2.6
5.2
7.8
Number of
Options Vesting
4,555,556
2,733,334
911,110
8,200,000
Of these share options granted, 7,000,000 options is subject only to the predetermined market condition and will vest immediately
when the Company’s ADS stock price reaches the respective target stock prices as noted above (“Predetermined Market Condition”).
The Vesting of the remaining 1,200,000 options are subject to a 3 year service period in addition to Predetermined Market Condition.
Activities relating to share options subject to with only Predetermined Market Condition are summarized as follows:
Outstanding at January 1, 2015
Granted
Exercised
Forfeited
Outstanding at December 31, 2015
Vested and expected to vest at December 31, 2015
Exercisable at December 31, 2015
Weighted-
Average
Exercise
Price
US$1.53
US$1.53
US$1.53
US$1.53
Number of
Options
—
7,000,000
—
—
7,000,000
7,000,000
3,888,889
F-57
Weighted-
Average
Remaining
Contractual
Term
(years)
Aggregate
Intrinsic Value
—
4.88
4.88
4.88
US$11,340,000
US$11,340,000
US$ 6,300,000
The weighted-average grant-date fair value of options granted with only Predetermined Market Condition during the year 2015 was
US$0.69, US$0.68, US$0.60 for Tranche I,II and III, respectively. The fair values for these shares options is calculated using the
Monte Carlo Simulation mode with the key following assumption:
Risk-free interest rate
Expected life (years)
Expected dividend yield
Volatility
Fair value of options at grant date
1.66%
4.49-5.0
0
62%
US$0.60-US$0.69
The share options subject to both Predetermined Market Condition and service conditions are as followed:
Outstanding at January 1, 2015
Granted:
Exercised
Forfeited
Outstanding at December 31, 2015
Vested and expected to vest at December 31, 2015
Exercisable at December 31, 2015
Number of
Options
—
1,200,000
—
1,200,000
1,200,000
18,530
Weighted-
Average
Exercise
Price
US$1.53
US$1.53
US$1.53
US$1.53
Weighted-
Average
Remaining
Contractual
Term
(years)
Aggregate
Intrinsic Value
—
—
4.88
4.88
4.88
US$1,944,000
US$1,944,000
30,019
US$
The weighted-average grant-date fair value of options granted with multiple conditions during the year 2015 was US$0.71, US$0.68,
US$0.60 for Tranche I,II and III, respectively. The fair values of the awards that are based on the market condition were calculated
using the Monte Carlo Simulation mode with the key following assumption:
Risk-free interest rate
Expected life (years)
Expected dividend yield
Volatility
Fair value of options at grant date
1.66%
4.49-5.0
0
62%
US$0.60-US$0.71
Modification of Share-Based Awards
On April 22, 2013, the Company modified the exercise prices of share options granted to 234 directors, officers and employees
granted to US$2.41 per share, which was the market price on the date of modification. The original exercise price of the modified
options ranged from US$7.36 to US$4.78.
F-58
On June 13, 2015, the company extended the expiration dates of the stock options granted to 25 directors, officers and employees,
with expirations dates of August 26, 2015 and December 10, 2015 to August 26, 2020, and the exercise price of these share options
was also reduced to US$1.78 which was the closing sale price on June 12, 2015.
On November 17, 2015, the Company modified the exercise prices of share options granted to 15 directors, officers and employees to
US$1.53 per share, the closing price of the last trading day. The original exercise price of the modified options ranged from US$1.78
to US$2.41.
During 2013, 2014 and 2015, as a result of these modifications, the Group recognized incremental compensation cost of RMB3.8
million (US$0.6 million), RMB0.9 million (US$0.2 million) and RMB11.8 million (US$1.8 million) respectively upon modification
for the vested portion.
The fair value of options, of which exercise prices were modified in April 2013, June 2015 and November 2015, were measured on
the modification date based on the Black-Scholes option pricing model with the following assumptions:
Risk-free interest rate
Expected remaining life (years)
Expected dividend yield
Volatility
Fair value of incremental cost
For the year
ended December 31, 2013
For the year
ended December 31, 2015
0.09%-0.24%
0.57-2.20
0
36%-65%
0.50%-1.12%
1.32-2.61
0
64%-71%
US$
0.16-US$0.43
US$
0.21-US$0.73
Share-Based Compensation
For the years ended December 31, 2013, 2014 and 2015, the Company recorded share-based compensation of RMB16.7 million,
RMB0.1 million and RMB32.0 million (US$4.9 million), respectively, for options granted to the Company’s employees and
directors, including incremental compensation cost due to the modification of the option exercise prices in April 2013, June 2015 and
November 2015.
As of December 31, 2015, there was approximately RMB25.4 million (US$3.9 million) unrecognized compensation cost, adjusted for
estimated forfeitures, related to non-vested options. This cost is expected to be recognized over a weighted-average period of 3.81
years. Total unrecognized compensation cost may be adjusted for future changes in estimated forfeitures.
F-59
26.2 Ordinary shares granted to Incsight Limited (“Incsight”)
Incsight is a company incorporated in the British Virgin Islands and wholly owned by Mr. Jun Zhu. On December 8, 2010, as
approved by the Board of Directors, the Company granted 1,500,000 ordinary shares to Incsight, subject to performance conditions,
of which 500,000 shares granted will vest when the Group achieves breakeven and 1,000,000 shares will vest when the Group’s
cumulative profit reaches US$5 million in a quarter subsequent to the quarter in which the Group breaks even. The ordinary shares
granted are not entitled to receive dividends until vested. The Board considered the grant of ordinary shares as an incentive to retain
Mr. Zhu’s services with the Group. The awarded non-vested shares would be valid for five years from December 8, 2010. For the
quarter ended September 30, 2014, the Group achieved breakeven. It is considered probable the performance targets will be met for
the total of 1,500,000 ordinary shares. The fair value of the granted non-vested shares was US$6.48 per share, the market price on the
date of grant. On December 7, 2015, 500,000 shares granted to Incsight Limited were vested. The awarded non-vested shares would
be valid for additional three years and expired on December 7, 2018. The Group recorded share-based compensation of RMB7.6
million, RMB2.2 million and RMB1.2million (US$0.2 million) for the years ended December 31, 2013, 2014 and 2015, respectively.
The following table reflected the activity of non-vested shares for the year ended December 31, 2015:
Non-vested at January 1, 2015
Granted
Forfeited
Vested
Non-vested at December 31, 2015
Weighted-
Average
Grant-
Date Fair
Value
US$6.48
—
—
US$6.48
US$6.48
Number of
Options
1,500,000
—
—
(500,000)
1,000,000
26.3 Ordinary shares granted to non-executive directors
In May 2011, the Board of Directors granted 30,000 ordinary shares to each of the Group’s four non-executive directors, of which
10,000 ordinary shares vest for each director on July 1 of each year from 2011 to 2013 so long as such directors continue their
services during the period. An aggregate of 40,000 ordinary shares vested in July 2011, 2012 and 2013, respectively. The fair value of
the shares granted was US$6.03 per share, being the market price on the date of the grant. The Group recorded share-based
compensation of RMB0.4 million, nil and nil for the year ended December 31, 2013, 2014 and 2015, respectively.
F-60
26.4 Stock options and ordinary shares granted by Red 5
In February 2006, Red 5 adopted a Stock Incentive Plan (“Red 5 Stock Incentive Plan”) under which Red 5 may grant to its
employees, director and consultants stock option to purchase common stock or restricted stock. As of December 31, 2010, 13,626,955
shares were reserved under Red 5 Stock Incentive Plan. In September, 2011, Red 5 further increased the number of common stocks
reserved to 22,855,591 shares. If an option shall expire or terminate for any reason without having been exercised in full, the reserved
shares subject to such option shall again be available for subsequent option grants under the plan. From the inception of this plan to
December 31, 2015, Red 5 granted a total of 38,191,879 options to its employees and directors at the exercise price ranging from
US$0.0001 to US$0.2450 per share, which vest over four years commencing from grant date. Options expire within a period of not
more than ten years from the grant date. An option granted to a person who is a greater than 10% shareholder on the date of grant
may not be exercisable more than five years after the grant date. As of December 31, 2015, option to purchase 10,649,893 shares of
common stock were outstanding and options to purchase 10,301,444 shares of common stock were available for future grant.
The following table summarizes the Red 5’s share option activities with its employees and directors:
Outstanding at January 1, 2015
Granted
Exercised
Forfeited
Outstanding at December 31, 2015
Vested and expected to vest at December 31, 2015
Exercisable at December 31, 2015
Weighted-
Average
Exercise
Price per
Option
US$0.122
US$0.045
US$0.120
US$0.061
US$0.061
US$0.087
Number of
Options
5,550,357
9,228,621
(300,000)
(3,829,085)
10,649,893
10,649,893
3,422,692
Weighted-
Average
Remaining
Contractual
Term
(years)
2.61
Aggregate
Intrinsic Value
US$1,133,349
US$
1,200
4.73
4.73
3.67
Nil
Nil
Nil
The option’s intrinsic value was calculated by the excess of the estimated fair value of Red 5’s common shares, which was
determined by the company with the assistance of an independent valuation firm.
The options expected to vest are estimated by applying the pre-vesting forfeiture rate assumptions to total unvested options. The total
intrinsic value of options exercised for the year ended December 31, 2013, 2014 and 2015 were US$14,762, US$162,279 and
US$1,200, respectively.
The fair value of options granted ranged from US$0.012 to US$0.149, measured on the grant date based on the Black-Scholes option
pricing model with assumptions made regarding expected term and volatility, risk-free interest rate and dividend yield:
Risk-free interest rate
Expected life (years)
Expected dividend yield
Volatility
F-61
0.78%-5.00%
4.00-6.00
0
38.89%-69.36%
In September 2012, Red 5 granted 6,122,435 shares of restricted common stock to two directors of Red 5 including Mr. Zhu for their
services to Red 5. Of these shares, 60% were vested on the grant date. The remaining shares shall become vested in a series of 36
successive equal monthly installments upon grantees’ completion of each month of service to Red 5 over the 36-month period
measured from the grant date.The following table reflected the activity of non-vested shares for the year ended December 31, 2015:
Non-vested at January 1, 2015
Granted
Forfeited
Vested
Non-vested at December 31, 2015
Number of
Options
612,244
—
—
(612,244)
—
Weighted-
Average
Grant-Date
Fair Value
US$0.01193
US$0.01193
US$0.01193
Red 5 recorded share-based compensation of RMB3.8 million, RMB1.0 million and RMB0.8 million (US$0.1million) for options and
shares of restricted common stock granted for the year ended December 31, 2013, 2014 and 2015, respectively. The share-based
payment awards were recorded as a component of noncontrolling interest in the consolidated financial statements.
As of December 31, 2015, there was approximately RMB0.8 million (US$0.1million) of unrecognized compensation cost, adjusted
for estimated forfeitures, related to non-vested share-based awards granted to Red 5 grantees. This cost is expected to be recognized
over 3.2 years. Total unrecognized compensation cost may be adjusted for future changes in estimated forfeitures.
26.5 Non-vested equity interest of Jiushi granted to employees
In July 2011, the Group granted 20% equity interest of the newly established Jiushi to two employees as an incentive to retain these
two employees’ services, which they will earn over three-year period. The fair value of the granted equity interest was estimated to be
RMB2.2 million. The Group recorded share-based compensation of RMB0.7 million, RMB0.4 million and nil for the years ended
December 31, 2013, 2014 and 2015, respectively.
27. RELATED PARTY TRANSACTIONS AND BALANCES
Transaction with equity investee
In 2013, the Group entered into an agreement with ZTE9, an equity investee of the Group, to jointly operate IPTV games in China
jointly. According to the agreement, the group pays ZTE9 a royalty fee for providing game contents on IPTV. Net royalty charged by
ZTE9 to the Group amounted to RMB6.8 million and RMB10.1 million (US$1.6 million) for year ended December 31, 2014 and
2015, respectively. The amount due to ZTE9 amounted to RMB6.3 million and RMB7.7 million (US$1.2 million) as of December 31,
2014 and 2015 respectively. In 2014, the Group lent RMB5.3 million (US$0.9 million) to ZTE9 to fund it operation. The loan was
interest-free and was due and repaid in June, 2015. In 2015, the Group lent RMB9.9 million (US$1.5 million) to ZTE9 to fund its
operation. The loan was interest-free and due in March-August, 2016. Total amount due from ZTE9 was RMB5.3 million and
RMB9.9 million (US$1.5 million) as of December 31, 2014 and 2015, respectively.
F-62
As of December 31, 2015, the amount due to Jiucheng Advertisement was RMB 4.0 million (US$0.6 million).
In 2014, the Group entered a license agreement with System Link Corporation Ltd., a 50% joint venture of the Group, for publishing
and operating Firefall for a five-year term in mainland China. Under this license agreement, System Link is expected to pay to Red 5
Singapore no less than US$160 million (including license fee and royalties) during the term of the agreement. In 2015, System Link
paid US$10 million to the Group as license. The Group records the amount as amount due to the related party and amortizes the
amount over the five-year period. As of December 31, 2015, the balance of amount due to System Link (non-current) is RMB 63.4
million (US$9.8million) and revenue recognized is RMB1.7 million (US$ 0.3 million).
28. LOSS PER SHARE
Loss per share is calculated as follows:
For the year
ended December
31, 2013
RMB
For the year
ended December
31, 2014
RMB
For the year
ended December
31, 2015
RMB
For the year
ended December
31, 2015
US$
(Note 3)
(526,261,572)
—
(526,261,572)
(86,622,470)
(21,076,744)
(107,699,214)
(304,828,354) (47,057,389)
(79,805,706) (12,319,878)
(384,634,060) (59,377,267)
Numerator:
Net loss attributable to ordinary shareholders
before accretion on redeemable noncontrolling
interest
Accretion on redeemable noncontrolling interest
Net loss attributable to ordinary shareholders
Denominator:
Denominator for basic and diluted loss per share –
weighted-average shares outstanding
23,174,823
23,164,695
23,235,848 23,235,848
Loss per share
- Basic and diluted
(22.71)
(4.65)
(16.55)
(2.56)
The Company had 4,797,391, 4,570,491 and 18,656,564 stock options, warrants and nonvested shares outstanding as of December
31, 2013, 2014 and 2015, respectively, which were excluded in the computation of diluted loss per share in the periods presented, as
their effect would have been anti-dilutive due to the net loss reported in such periods.
F-63
29. RESTRICTED NET ASSETS
Pursuant to laws applicable to entities incorporated in the PRC, the subsidiaries and the VIEs of the Group in the PRC must make
appropriations from after-tax profit to non-distributable reserve funds. These reserve funds include one or more of the following: (i) a
general reserve, (ii) an enterprise expansion fund and (iii) a staff bonus and welfare fund. Subject to certain cumulative limits, the
general reserve fund requires annual appropriation of 10% of after tax profit (as determined under accounting principles generally
accepted in the PRC at each year-end) until the accumulative amount of such reserve fund reaches 50% of their registered capital; the
other fund appropriations are at the subsidiaries’ discretion. These reserve funds can only be used for specific purposes of enterprise
expansion and staff bonus and welfare are not distributable as cash dividends. The appropriation to these reserves by the Group’s
PRC entities were nil, nil and nil for the years ended December 31, 2013, 2014 and 2015. The accumulated reserves as of December
31, 2015 is RMB 3.8 million. In addition, due to restrictions on the distribution of registered capital from the Company’s PRC
subsidiaries, the PRC subsidiaries’ registered capital of 19.5 million as of December 31, 2015, were considered restricted. As a result
of these PRC laws and regulations, as of December 31, 2015, approximately RMB23.3 million (US$3.6 million), were not available
for distribution to the Company by its PRC subsidiaries in the form of dividends, loans or advances.
30. NONCONTROLLING INTEREST
As of December 31, 2015, the Group’s non-controlling interest mainly included equity interests in Red 5,Mengxiang Hulian, The9
Education, and equity awards granted as compensation by the Group’s subsidiaries. The following schedule shows the effects of
changes in the ownership interest of The9 Limited in its subsidiaries on equity attributed to The9 Limited for the years ended
December 31, 2013, 2014 and 2015.
Net loss attributable to The9 Limited
Transfers (to) from the noncontrolling interest
Increase in The9 Limited’s additional
paid-in capital for issuance of shares
by Red 5 upon stock option exercise
Change in equity interest attributable to
non-controlling interest due to
restructuring of Red 5 Singapore (1)
Change in The9 Limited’s additional
paid-in capital for adjustment on
noncontrolling interest due to change
in ownership interest as a result of
loan conversion (2)
Change in The9 Limited’s additional
paid-in capital for adjustment on
noncontrolling interest as a result of
issuance of common shares of Red 5
upon vesting of stock options and
restricted shares
Change from net loss attributable to The9
Limited and transfers (to) from
noncontrolling interests
December 31, 2013
December 31, 2014
RMB
RMB
December 31, 2015
RMB
(526,261,572)
(86,622,470)
(304,828,354)
25,992
552,426
75,563
—
15,068,103
—
(31,784,850)
—
3,072,133
(42,692,211)
80,903
(523,163,447)
(145,479,002)
(304,671,888)
(1)
In August 2014, Red 5 issued 27,438,952 Series B redeemable convertible preferred shares of Red 5 to a new investor (see Note
31). As the license to publish Firefall belongs to Red 5 Singapore (Note 11), as a condition for the investment by the new
investor, the Group is required to transfer the license to Red 5. As such, in June 2014, the Group transferred its equity interests
in Red 5 Singapore, a wholly owned subsidiary of the Group to Red 5, a 79.2% owned subsidiary at a nominal price. At the time
of transfer, 20.8% of the accumulated deficit of Red 5 Singapore, amounted to RMB 15,068,103, was attributable to the
noncontrolling interest of Red 5 with no consideration, which was recorded as an equity transaction in the Consolidated
Statements of Changes in Equity.
(2)
In August 2014, the Group converted its convertible loan and certain other loans due from Red 5 with a book value of US$50.0
million (RMB307.6 million), into 63,301,276 common shares of Red 5. The equity of Red 5 increased by RMB307.6 million
while the impact attributable to noncontrolling interest of Red 5 was RMB31,784,850 as a result of the loan conversion.
F-64
31. REDEEMABLE NON-CONTROLLING INTEREST
In January 2014, Red5 issued 27,438,952 Series B redeemable convertible preferred shares (“SBPS”) to a third party investor,
Shanghai Oriental Pearl Culture Development Co., Ltd., (“Oriental Pearl”), for an aggregate consideration of RMB118.3 million
(US$19.2 million). In conjunction with the issuance of SBPS, Oriental Pearl also purchased 5,948,488 common shares of Red 5 from
two executives of Red 5 at the same per share price as the per share price of SBPS for an aggregate consideration of RMB25.6
million(US$4.2 million). The purchase price for these common shares was determined to be less than fair value as the transaction as
contemplated in conjunction with the issuance of the SPBS. The difference between the purchase price and fair value of SBPS as
determined by the Group with the assistance of independent valuation firm, which amounted to RMB131.3 million (US$21.2
million), was recognized as a compensation paid to the two executives in the amount of RMB13.0 million (US$2.1 million).
As of December 31, 2014, the Group considered the redemption of the SBPS to be possible. The Group accreted the carrying value of
SBPS to redemption value using the effective interest rate method over the period from the issuance date to the Redemption Date.
The key terms of the SBPS are as follows:
Conversion
Each SBPS may be converted at any time into common shares at the then applicable conversion price. The initial conversion ratio is
1:1, subject to adjustment in the event of (i) share splits, share combinations, share dividends or distribution, other dividends,
recapitalizations and similar events, or (ii) issuance of common shares at a price per share less than the conversion price in effect on
the date of or immediately prior to such issuance. In that case, the conversion price shall be reduced concurrently to the subscription
price of such issuance.
F-65
The SBPS shall be automatically converted into common shares immediately prior to the consummation of a public offering of
Red 5’s shares wherein gross proceeds are at least US$30,000,000, immediately following the public offering (the “Qualifying IPO”).
The conversion option can only be settled by issuance of common shares except that fractional shares may be settled in cash.
Dividends
The holder of each share of SBPS shall be entitled to receive dividends at the rate per share of $0.038237 per annum if and when a
dividend is declared. The Preferred Shares participate in dividends on an as-converted basis and must be paid prior to any payment on
common shares.
Upon conversion, any declared or accrued but unpaid dividends will be converted into common shares at the same applicable
conversion price.
Redemption
At any time on or after April 1, 2017, if requested by at least 50% of the holders of SBPS then outstanding , Red 5 shall redeem all of
the outstanding SBPS at a redemption price equal to 200% of the issuance price in three equal annual installments. The full amount of
the redemption price due but not paid shall accrue interest daily at a rate of 10% per annum from the issuance date of SBPS.
Voting
Each SBPS has voting rights equivalent to the number of common shares to which it is convertible at the record date. The holders of
SBPS shall vote together with the common shareholders, and not as a separate class or series, on all matters put before the
shareholders.
Liquidation
The holders of Preferred Shares have preference over holders of common shares with respect to distribution of assets upon voluntary
or involuntary liquidation of the Company. The holders of Preferred Shares shall be entitled to receive 100% of the original issue
price(“preferred liquidation”). The holders of Preferred Shares are also entitled to distribution of remaining assets from preferred
liquidation, along with other shareholders, while the total distribution entitled to the holders of Preferred Shares should not exceed
200% of the original issue price.
F-66
A reconciliation of Redeemable noncontrolling interest is as follows:
Redeemable noncontrolling interest opening balance
Issuance of Redeemable noncontrolling interest
Net loss attributable to redeemable noncontrolling interest
Accretion of Redeemable noncontrolling interest
Redeemable noncontrolling interest ending balance
Year ended December 31,
2015
2014
131,296,977
— 131,497,104
—
(20,876,617) (32,697,713)
21,076,744 79,805,706
131,497,104 178,605,097
32. DISPOSAL OF SUBSIDIARIES
In July 2014, the Group entered into an agreement to sell its VIE, Huopu Cloud, for a total consideration of RMB200 million
(US$32.2 million) to a third-party purchaser. Pursuant to the agreement, the Group paid RMB30 million (US$4.8 million) to Huopu
Cloud’s development team to retain them in Huopu Cloud and undertook Huopu Cloud’s operating costs and expenses from the date
of disposal to December 31, 2014 in the amount of RMB19 million (US$3.1 million). Huopu Cloud developed and held a web game
Qijiguilai. As of the transfer date, the net assets held by Huopu Cloud amounted to RMB11 million (US$1.8 million).The Group
recognized a net gain of RMB 140 million (US$22.5 million) upon the disposal of Huopu Cloud in 2014.
In 2014, the Group established a subsidiary with two individual shareholders, Shanghai Kaiyue Information and technology Co., Ltd.
(“Kaiyue”), while the Group owned 85% equity interest of Kaiyue. Kaiyue developed and held a mobile application named
KingReader for online reading. In December 2014, the Company sold their 85% equity interest of Kaiyue to a third-party investor for
an aggregate consideration of RMB 25.5 million (US$4.1 million), and recognized a net gain of RMB 25.5 million (US$4.1 million)
upon the disposal of the subsidiary in 2014.
33. COMMITMENTS AND CONTINGENCIES
33.1 Operating lease commitments
The Group has entered into operating lease arrangements relating to the use of certain premises and internet data centers. Future
minimum lease payments for non-cancellable operating leases as of December 31, 2015 are as follows:
F-67
2016
2017
2018
2019
2020
RMB
8,389,540
7,159,779
6,819,782
6,497,790
5,414,825
34,281,716
US$
(Note 3)
1,295,122
1,105,279
1,052,793
1,003,086
835,905
5,292,185
Total rental expenses amounted to RMB38.2 million, RMB22.2 million and RMB19.4 million (US$3.0 million) for the years ended
December 31, 2013, 2014 and 2015, respectively.
33.2 Contingencies
The Group may be subject to other legal or administrative proceedings in the ordinary course of business. The Group does not believe
that any currently pending legal or administrative proceeding to which the Group is a party will have a material adverse effect on the
business or financial condition.
34. SEGMENT REPORTING
The Group operates in one segment whose business is developing and operating online games and related services. The Group’s chief
operating decision maker is the chief executive officer, who reviews consolidated results when making decisions about allocating
resources and assessing performance of the Group. The Group generates its revenues from customers in the PRC, North America and
other areas.
The following geographic area information includes revenue based on location of players for the years ended December 31, 2013,
2014 and 2015:
PRC
North America
Other areas
Total
A majority of the Group’s assets are located in PRC.
35. SUBSEQUENT EVENTS
2013
RMB
2014
RMB
2015
RMB
US$ (Note 3)
85,483,458 41,969,350 33,201,421 5,125,416
13,135,914 14,906,530 8,382,753 1,294,074
7,401,011 4,827,157 745,185
6,156,697
104,776,069 64,276,891 46,411,331 7,164,675
2015
In March 2016, the Group entered into a non-binding memorandum of understanding (“MOU”) with L&A International Holding
Limited (“L&A”), a Cayman Island Company with shares publicly listed in Hong Kong, and a certain other shareholder of Red 5
Studios, Inc. (“Red 5”). Under the terms of this MOU, the Group will exchange approximately 30.6% of its equity interest in Red 5
for such number of newly issued shares of L&A of equivalent value based on a valuation agreed by all parties. The other participating
shareholders of Red 5 will exchange an aggregate of approximately 14.4% equity interest in Red 5 based on the same terms.
In March 2016, Bank of Shanghai (BOS) issued a commitment letter whereby BOS agrees to grant the Group a credit facility of
RMB50 million (US$7.7 million). The Group can apply to withdraw the funding from BOS should they require liquidity for its
operations. As of the report date, the Group had withdrawn RMB4.9 million (US$0.8 million) under this credit facility.
F-68
ADDITIONAL FINANCIAL INFORMATION OF PARENT COMPANY -
FINANCIAL STATEMENTS SCHEDULE I
THE9 LIMITED
FINANCIAL INFORMATION OF PARENT COMPANY
CONDENSED STATEMENTS OF COMPREHENSIVE LOSS
Cost of revenue
Gross loss
Operating expenses:
Product development
Sales and marketing
General and administrative
Total operating expenses
Loss from operations
Interest income (expenses), net
Fair value change on convertible bonds and warrants
Other income (expenses), net
Loss before income tax expense and share of loss in equity method
investments
Income tax expense
Equity in income (loss) of subsidiaries and VIEs
Net loss
Other comprehensive income (loss)
Unrealized loss on available-for-sale investment
Currency translation adjustments
Total comprehensive loss
F-69
2013
RMB
(127,706)
(127,706)
2014
RMB
2015
RMB
2015
US$
—
—
—
—
—
—
(1,284,261)
(14,536,253)
(32,056,416)
(47,876,930)
(48,004,636)
869
—
(69,198)
(48,072,965)
—
(478,188,607)
(526,261,572)
(16,600)
(2,259,470)
(528,537,642)
632,437
0
(70,941)
(120,735)
(10,951)
(18,638)
(9,392,137) (38,475,787) (5,939,640)
(8,759,700) (38,667,463) (5,969,229)
(8,759,700) (38,667,463) (5,969,229)
(904,450)
(5,858,848)
(7,129,161) (1,100,553)
(350,016)
(2,267,335)
32
—
9,756
—
(8,749,912) (53,922,807) (8,324,248)
—
(77,872,558) (250,905,547) (38,733,141)
(86,622,470) (304,828,354) (47,057,389)
—
—
348,437
—
812,933
(86,274,033) (299,562,338) (46,244,456)
—
5,266,016
ADDITIONAL FINANCIAL INFORMATION OF PARENT COMPANY -
FINANCIAL STATEMENTS SCHEDULE I
THE9 LIMITED
FINANCIAL INFORMATION OF PARENT COMPANY
CONDENSED BALANCE SHEETS
December 31,
2014
RMB
December 31,
2015
RMB
December 31,
2015
US$
ASSETS
Cash and cash equivalents
Prepayments and other current assets, net
Amounts due from intercompany
Total current assets
Investments in subsidiaries
Total assets
LIABILITIES
Current liabilities:
Accounts payable
Other payables and accruals
Warrants
Total current liabilities
Convertible notes
Total liabilities
SHAREHOLDERS’ EQUITY
Ordinary shares
Additional paid-in capital
Statutory reserves
Accumulated other comprehensive loss
Accumulated deficit
Total shareholders’ equity
Total liabilities, and shareholders’ equity
F-70
28,984
912,003
4,474
2,754,295
140,791
55,258
1,425,500,136 220,059,300
1,188,956,211
1,191,765,764
1,426,441,123 220,204,565
(1,092,897,996) (1,420,228,235) (219,245,461)
959,104
6,212,888
98,867,768
164,162
676,958
841,120
—
841,120
22,879
148,204
591,189
3,829,603
64,414,941
9,943,953
68,392,748 10,558,021
135,182,536 20,868,587
203,575,284 31,426,608
1,917,620
1,885,153
2,075,900,461
28,071,982
(8,638,604)
296,030
2,080,041,288 321,103,042
4,333,567
(520,638)
(1,999,192,344) (2,304,020,698) (355,679,505)
(197,362,396) (30,467,504)
959,104
28,071,982
(3,372,588)
98,026,648
98,867,768
6,212,888
ADDITIONAL FINANCIAL INFORMATION OF PARENT COMPANY –
FINANCIAL STATEMENTS SCHEDULE I
THE9 LIMITED
FINANCIAL INFORMATION OF PARENT COMPANY
CONDENSED STATEMENTS OF CASH FLOWS
Cash flows from operating activities:
Net loss
Adjustments for:
Employee share-based compensation expense
Fair value change on warrants liability
Amortization of discount on convertible note
Equity in income (loss) of subsidiaries and VIEs
Change in prepayments and other current assets
Change in accounts payable
Change in amounts due from intercompany
Change in other payables and accruals
Net cash used in operating activities
Cash flows from financing activities:
Proceeds from stock option exercises
Proceeds from the issuance of convertible bonds
Payment for the issuance cost related to convertible bonds
Repurchase of ordinary shares
Net cash provided by (used in) financing activities
Net change in cash and cash equivalents
Cash and cash equivalents, beginning of year
Cash and cash equivalents, end of year
2013
RMB
2014
RMB
2015
RMB
2015
US$
(526,261,572)
(86,622,470) (304,828,354) (47,057,389)
24,683,804
—
—
478,188,607
14,253,727
(31,607)
32,990,799
1,858,984
25,682,742
4,304,447
—
(29,030,699)
(24,726,252)
956,490
4,832,694
5,789,184
—
—
2,337,019 33,184,307 5,122,772
7,129,161 1,100,553
402,879
2,609,771
77,872,558 250,905,547 38,733,141
(132,259)
(2,463)
4,294,984 (236,543,924) (36,516,087)
988,255
(1,702,034)
(3,847,524) (242,014,471) (37,360,598)
(856,745)
(15,958)
(199)
(27,382)
6,401,724
812,635
—
— 260,068,680 40,147,686
(20,779,520) (3,207,805)
—
812,635 239,289,160 36,939,881
(420,717)
(2,725,311)
425,191
2,754,295
4,474
28,984
(3,034,889)
5,789,184
2,754,295
ADDITIONAL FINANCIAL INFORMATION OF PARENT COMPANY -
FINANCIAL STATEMENTS SCHEDULE I
F-71
THE9 LIMITED
FINANCIAL INFORMATION OF PARENT COMPANY
NOTES TO SCHEDULE I
1) Schedule I has been provided pursuant to the requirements of Rule 12-04(a) and 5-04(c) of Regulation S-X, which require
condensed financial information as to the financial position, changes in financial position and results of operations of a parent
company as of the same dates and for the same periods for which audited consolidated financial statements have been presented when
the restricted net assets of consolidated subsidiaries exceed 25 percent of consolidated net assets as of the end of the most recently
completed fiscal year.
2) As disclosed in Note 1 to the consolidated financial statements, the Company was incorporated in December, 1999 in the Cayman
Islands to be the holding company of the Group principally engaged in the development and operation of online games and internet
related businesses, including massively multiplayer online games (“MMOGs”), mobile games and TV games.
3) The condensed financial information has been prepared using the same accounting policies as set out in the consolidated financial
statements except that the equity method has been used to account for investments in its subsidiaries and VIE. For the parent
company, the Company records its investments in subsidiaries and VIE under the equity method of accounting as prescribed in ASC
323, Investments-Equity Method and Joint Ventures . Such investments are presented on the Condensed Balance Sheets as
“Investment in subsidiaries and VIE” and the subsidiaries and VIE’ profit or loss as “Equity in income/loss of subsidiaries” on the
Condensed Statements of Comprehensive Loss. Ordinarily under the equity, an investor in an equity method investee would cease to
recognize its share of the losses of an investee once the carrying value of the investment has been reduced to nil absent an
undertaking by the investor to provide continuing support and fund losses. For the purpose of this Schedule I, the parent company has
continued to reflect its share, based on its proportionate interest, of the losses of subsidiaries and VIE regardless of the carrying value
of the investment even though the parent company is not obligated to provide continuing support or fund losses.
4) As of December 31, 2014 and 2015, there were no material contingencies, significant provisions of long-term obligations,
mandatory dividend or redemption requirements of redeemable stocks or guarantees of the Company. No dividend was paid by the
Company’s subsidiaries to the Company in 2013, 2014 and 2015.
5) Translations of balances in the additional financial information of Parent Company — Financial Statements Schedule I from RMB
into US$ as of and for the year ended December 31, 2014 and 2015 are solely for the convenience of the readers and were calculated
at the rate of US$1.00 = RMB6.4788, representing the noon buying rate set forth in the H.10 statistical release of the U.S. Federal
Reserve Board on December 31, 2015. No representation is made that the RMB amounts could have been, or could be, converted,
realized or settled into US$ at that rate on December 31, 2015, or at any other rate.
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